American Express Co. (NYSE: AXP) following 4Q earnings, which continued to be impacted by weaker business and consumer spending. Still, the recent sequential improvement in spending is encouraging.
With respect to billed business, the travel & entertainment categories have been particularly hard hit, though spending has improved in other categories, particularly in e-commerce and certain portions of retail. We note that non-T&E categories account for 70% of AXP’s billing volume. The company’s customers, who tend to have higher incomes than those of other credit card companies, also have better credit scores. As such, we expect AXP cardholders to be more insulated from economic distress, and look for billed business to hold up better. With revenues still below recent trends, management is keeping a close eye on costs, and was able to cut 4Q costs by 9%. AXP appears keenly aware of elevated competition in the credit card industry, noting that rewards and pricing in particular have become very heated. However, it has also emphasized the strong cardholder loyalty and other differentiating factors of its premium cards. While we believe that AXP will maintain share at the high end of the premium card market, we expect the lower tier of that market to face increased competition from the Sapphire card and other lower-priced cards with similar rewards benefits.
Merchant acceptance remains a top ‘pain point’ for AXP card members. The company has been making progress on this front, emphasizing the benefits of its card members’ higher spending; however, AXP’s greater transaction fees are often an offsetting negative for merchants. The company is aiming to reach merchant-acceptance parity with other card networks by using modified pricing in some segments, as well as by focusing on franchises and partnerships. In our view, the company has competitive advantages with its closed-loop platform, in which it acts as merchant acquirer, merchant processor, issuer processor and payment issuer. This is particularly true in the co-brand space, as the closed-loop system provides the company with data on consumer spending habits that allows it to target offerings and promotions more effectively. The closed-loop system also helps with fraud prevention.
Among large competitors, only Discover Financial has a similar closed-loop system. However, we do not believe that Amex has been as innovative in the payments space as others, such as PayPal, which have developed in-app, in-store and online payment mechanisms to compete with traditional operators. We believe the recent selloff provides an opportunity to acquire the high-quality AXP shares, which are currently trading at 17-times our 2021 EPS estimate.
On January 26, American Express reported 4Q20 earnings of $1.76 per share. Net revenues declined 18%, to $9.4 billion, hurt mostly by a drop in discount revenues as billed business fell – particularly as commercial customers cut back on travel-related spending – as well as reduced net interest income. Total operating expenses fell 9%, to $7.6 billion. Marketing expenses rose 6%, the only major cost category to increase, while business development costs declined 15%, and spending on card member rewards and card member services fell 16% and 44%, respectively. Lending net write-offs were 1.9% of loans in 4Q. The company also had a $111 million recapture of loss provisions, versus a prior-year provision of $1.02 billion, after setting aside $4.2 billion in the first half for expected credit defaults.
EARNINGS & GROWTH ANALYSIS
Worldwide billed business was down 33% in 2Q20, though this moderated to a decline of 20% in 3Q and 16% in 4Q. We expect card spending, and thus billed business, to show improvement in 2021 as travel restrictions ease and spending recovers. While AXP is perhaps perceived as having significant exposure to travel & entertainment spending, we note that the proportion of T&E spending on its cards is about 30%. One revenue line item that should hold up well is net card fees, which are accrued on the balance sheet and booked over the course of a year. We expect loss provisions to remain a big swing factor in 2021.
AXP has offered a customer pandemic relief (CPR) program that allows card members impacted by COVID-19 to receive payment deferrals of 1-3 months, waivers on interest and certain fees, and protection from credit bureau reporting. The company had been ramping up its card lending portfolio in recent years, which was ill-timed given the current downturn. Still, we believe that capital levels are strong and credit losses manageable.
The discount rate has been generally steady in recent years, and was 2.25% in 4Q. Movements in the discount rate generally reflect merchant renegotiations, volume-driven rate changes, and the ramp-up of cards with lower discount rates. Amex has been pushing aggressively to compete across the credit card landscape, which could put pressure on this metric. Unlike most banks, AXP’s balance sheet is liability-sensitive and will thus benefit from a lower interest rate environment. The company has estimated that a 25-basis-point decrease in interest rates would add about $0.01 to quarterly EPS, although a more sluggish economy would impact results in the opposite direction.
FINANCIAL STRENGTH & DIVIDEND
AXP reported a Tier 1 common equity ratio of 13.5% at the end of 4Q20 under Basel III, up from 11.9% a year earlier. AXP has targeted a ratio in the 10%-11% range. The company suspended share buybacks in 2020 to conserve capital, but announced a resumption of buybacks with a $440 million plan for 1Q21. Amex’s long-term capital allocation target is to return 50% of capital to shareholders and retain 50% for growth initiatives and acquisitions.
MANAGEMENT & RISKS
American Express is led by Chairman and CEO Stephen Squeri, who succeeded Kenneth Chenault following his retirement in February 2018. Jeffrey Campbell is EVP & CFO. In fact, merchant discount fees now account for about 60% of the company’s revenue. However, in contrast to Visa and MasterCard, American Express has a large card loan portfolio of about $70 billion that generates added revenues from loan growth and/or margin expansion.
A long-term concern is that the discount rate – the rate the company charges merchants for transactions – declines faster than we expect. If it does, AXP will need to add even more accounts and drive more spending volume to compensate for the lost revenue. At the same time, the discount rate gap between American Express and both Visa and MasterCard has narrowed in recent years, thereby increasing the value proposition for Amex merchants. AXP has also demonstrated to merchants that card member spending is typically much greater on Amex cards than on either Visa or MasterCard.
This follows a sharp correction early last year on concerns about the economic impact of the coronavirus. Spending volume, which faced significant pressure early in the pandemic, has rebounded in recent quarters, and we expect this gradual recovery to continue into 2021, driven by improving consumer and business confidence. We also see secular benefits from greater usage of credit cards relative to cash and checks.