Description

Introduction:

I believe that at its current price, American Express represents a compelling opportunity to own a high quality Company with a wide moat trading at an attractive valuation.  Further, management returns a sizable portion of cash to shareholders and has demonstrated strong capital allocation discipline.  The stock is currently at $79.50 per share compared to its 52 week low of $76.53 due to the loss of an important co-branded card relationships with CostCo and Jet Blue and recent legal loss (under appeal) that would give merchants the ability to charge less to customers paying with a competitors’ card, which typically have lower merchant fees.  I believe the market is overreacting and like the opportunity to buy a great company at a 14x P/E (well below the market multiple of 21x).  I believe this is a case where the market is overly focused on growth, and not on the high quality of the business and capital allocation discipline that management has shown (both by rejecting business that can’t earn its cost of capital and returning excess capital to shareholders).

Business Overview:

American Express (“AXP” or the “Company”) is one of four major credit card companies.  The Company primarily operates as a charge card company where customers are required to pay their balances each month.  The Company has 16% market share making it second only to Visa.  The Company’s market share has remained steady over time.  The Company’s cardholders spend over 3x the average of a typical credit card holder.    

The Company generates most of its revenue from credit card fees paid by merchants for accepting AmEx.  The Company also generates revenue from interest on card holder balances and fees paid for having the card by customers.  Its primary expenses relate to marketing and rewards.  The Company charges merchants a higher rate than most of its competitors for using the card, but then passes much of that on the customer in the form of better rewards.  This has led to AmEx being used by the more affluent who are using the cards for the rewards instead of for the extension of credit.  This creates a virtuous circle where the most affluent customers are attracted to AmEx, enabling it to spend less money on charge-offs, collections efforts, etc. and spend more money on rewards, which then attracts more affluent customers. 

The Company’s primary assets are cardholder receivables, which are funded through deposits from its bank customers and publicly traded debt.  The mix of bank deposits has been increasing over time.  The fact that the Company is a well-capitalized bank puts it in a much better position to weather a financial market crisis than during the last crisis. 

The Global payment industry has been growing at a 7% CAGR over the past five years, and should structurally grow due to increased consumer spending over time.  Analysts are expecting it to grow 8% through 2020. 

The Company’s stock price has declined recently, because it lost an important co-branded card relationship with Costco when it refused a deal below its cost of capital.  The loss of this relationship will mean that AmEx is unlikely to grow over the next couple of years.  However, I believe you aren’t paying for much growth at the current price.  Further, there are concerns with a recent court ruling that says that merchants can offer a discount to customers paying with Visa or another card (currently Merchants can already offer discounts for cash).  It is unlikely merchants will do so, because the price difference is so small (as high as 2%), and runs the risk of alienating their most affluent, highest spending customers.  AmEx customers spend over 3x more on average than comparable credit card customers.

Management:

The Company is run by Kenneth Chenault who owns ~$75mm of stock or ~40x his base salary.    

Management has done an excellent job of returning capital to shareholders, returning ~75% of cash flow to shareholders over the past 3 years.

Risks:

1.      Merchant’s Steer Customers to Other Cards Due to Court Ruling:  See discussion above.

2.      Leverage:  The Company is currently levered and is a bank. Small changes in asset value can greatly impact equity.  I gain comfort with this because the Company could withstand a financial crisis type shock and still be well capitalized.

3.      Disruption:  If Paypal and others become more acceptable forms of payment they may take share from AmEx.  I gain comfort given Amex’s model of focusing on more affluent customers using the card for rewards points, not just a payment mechanism.  Further, AmEx has a history of innovation, and has been a very difficult business to kill over its 165 year history.

Catalyst

Company begins to grow again in 2017 causing multiple expansion.