Though a nasty ‘one-two’ punch on the way down, sensitivity to both consumer spending and loan losses was always going to lead to a strong recovery for credit card issuer American Express (AXP). The headline numbers maybe mask how lumpy that recovery is, but positive comps versus pre-COVID times were proof enough that things were heading in the right direction in Q3. I say ‘were’ – Omicron and renewed COVID fears do present a bit of an unknown right now, though I’m really erring on the side of caution with that.
AmEx stock has also had a much better time of it this year. It has returned over 35% heading into year-end, albeit those gains were front-loaded in the first half. Still, that puts it ahead of the S&P 500 and fellow network owner Discover, but behind major card lender Capital One.
It also makes the investment case a bit trickier at this point. I mean, this isn’t really a great market for buying cheap, high quality blue chips (and that’s putting it mildly). American Express is no exception in that sense, and bears can point to a ‘high-teens’ PE as being a harbinger of poor forward returns with some justification. Having said that, it’s not like there’s a whole host of more obvious options out there. A 5%-plus earnings yield doesn’t look too bad, then, but it doesn’t really leave the stock primed for long-term double-digit annualized returns either.
Well Into Recovery Mode
Although lumpy beneath the surface, headline numbers have definitely showcased the strength of the recovery here. Most of the company’s top line comes via spending-linked discount revenue, which is to say that when somebody spends $100 on their Amex card, the merchant only receives around $97.70 of that. The rest is shipped off to the coffers of New York-based American Express. Anyway, discount revenue was $6.7b in Q3, up around 34% on the 2020 period and a shade higher than pre-COVID 2019. That helped propel a surge in overall quarterly revenue, which at $10.9b was 25% higher than the year-ago period.
Like with the banks, unexpected strength in credit quality has also been a massive boon to the bottom line here. The company booked a $4.7b provision expense last year, but it has been in a position to reverse some of that as credit losses haven’t come in like many feared. Reserve releases have contributed around $1.4b to pre-tax profit so far this year, and that helped nudge Q3 EPS above 2019 levels.
Total cards-in-force increased 7% year-on-year (and 3.5% quarter-on-quarter) to 119.2 million, while volumes have also now trended above levels before the pandemic. Billed business – basically total volume on Amex branded cards and so on – came in at $280b in Q3. That was around 30% higher than Q3 2020, and 4% higher than pre-COVID Q3 2019 after adjusting for foreign exchange. Total network volumes growth has likewise moved out of the red versus pre-COVID times, increasing 4% in Q3 versus same-period 2019 levels. A recovery in consumer spending provided the driving force for that, especially among ‘Millennials’ and ‘Gen-Z’, as well as small and mid-size enterprises. Large and global corporate card spending – heavily weighted to Travel & Entertainment (“T&E”) – remains subdued, though.
Omicron Probably Only A Slight Drag
Renewed waves of COVID infections were always a potential threat here given the nature of the business. T&E, around 30% of pre-COVID billed business, was still way off 2019 levels even in Q3, especially outside the US. Still, there were signs of recovery within that, with restaurant spending around 4% higher than pre-COVID levels for example.
While Omicron does cast a bit of a shadow on that, the early indications are that other spending is still strong. Consumer retail spending, for instance, was up 30% versus 2019 levels, with that accurate as of early December according to the CFO. Overall billed business was around 11% higher as per the same source.
Competition Likely The Main Headwind
While Omicron might not have the negative impact feared, there are more than a few headwinds here. For one, net interest income (“NII”), while not a massive part of the revenue mix, is still fairly weak. NII clocked in at $2b in Q3, up on the year-ago period thanks to cheaper funding, but down around 10% on 2019 levels. Part of that is due to the lower loan balance – with stimulus measures and lower consumer spending helping consumers pay down credit card debt during the pandemic. That has since reversed somewhat, though the Q3 ending loan balance of $79b remains around $10b lower than Q3 2019.
Also, the pop from lower provisioning is not recurring for obvious reasons, and profit performance in ‘pre-provision’ terms was less impressive, falling both quarter-on-quarter and versus pre-COVID 2019. Lower reserves might still juice profit depending on the recovery, but the big gains were in 2021. Credit quality does remain strong, though, with loans 30+ days past due only around 0.7% of loans outstanding. The net charge-off rate also fell again, both sequentially and year-on-year, to 0.6% in Q3.
On a longer-term basis, competition is likely to be the main worry, and it’s no secret that the likes of JPMorgan and Wells Fargo have been eyeing up that double-digit net interest yield and high ROTE. Expenses have been rising here as a result, with the company spending more on things like cardmember rewards to stay competitive. There is always the short/mid-term risk of losing a co-branded card partner, too, like with Costco a few years back. Big partnerships here include the likes of Delta Air Lines and Marriott International, with the former accounting for circa 10% of billed business.
A ‘So-So’ Valuation, But Not Out Of Line
American Express stock currently trades around the $165 mark, putting it at circa 18x earnings and 5.8x TBV per share. The company can at least boast a ROTE in the 30-35% area, but the stock clearly isn’t going cheap. I don’t really want to single out American Express on that – you can make the same point about so many blue chip stocks, and in that sense it isn’t out of the line with the wider market – but multiple expansion has nonetheless been a big part of the story here this past decade. If my math is right then it has juiced returns to the tune of 4-5% per annum, just to put a number on it.
Looking ahead, earnings growth in the mid-single-digit per annum area seems to be where most analysts land, and that seems sensible given the skew of the business toward wealthier consumers in the US. It might also be able to support high single-digit to low double-digit annualized returns after buybacks and dividends, though at this point we are probably relying on continued strength in the bull market for that.
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