Not A Status Symbol Anymore

By Chad Henage - July 10, 2012 | Tickers: AXP, DFS, MA, V | 0 Comments

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If you looking for proxy of the health of the American economy, you might not find a better example than American Express (NYSE: AXP). Looking at the company's most recent earnings report, you find out a lot about how the economy is really doing. On the news, all we seem to hear is that the economy is barely stable. American Express seems to be proving this theory wrong, with recent revenues increasing by 8%, and earnings-per-share growth of 10%. Considering the company's fortunes are heavily tied to the consumer, these results seem pretty good if the economy is limping along. Let's take a look at each division, and then take a look at the one persistent problem I found that investors should take note of.

U.S. & International Card Services:

American Express operates in four different segments: U.S. Card services, International Card Services, Global Commercial, and Global Network. While all four divisions showed revenues increasing, net income showed mixed results. U.S. Card Services for example, showed revenue up 9%, while net income jumped by 35%. The primary difference between the rate of growth in revenues and net income, was the company did not spend as much on marketing expenses. A persistent problem throughout the earnings report was, the company increased its provision for losses significantly. In this division alone, provision for losses jumped from $47 million last year, to over $300 million this year. 

International Card Services showed revenues up 8%, versus net income was up 4%. The primary reason that income did not keep up with revenues, was due to a 13% increase in marketing and promotional activity. This division saw the most significant jump in the provision for losses, with an increase of almost tenfold.

Global Commercial Services:

The one really troubling division of American Express, is global commercial services. Revenue was up by 3%, however net income was down by 4%. The primary reason for this divergence was, the company spent 23% more on marketing and promotional activity. Once again, American Express increased their provision for losses, in this case by about 50%.

Global Network and Merchant Services:

American Express global network and merchant services division was the brightest spot on the earnings report, showing revenue up 10%, and net income increasing 14%. Much of the increase in this division, comes from the fact that there were nearly 7% more total cards in force versus last year. Another contributing factor was, the average basic cardmember spending rate increased by nearly 10% year over year.

Past Due & Loss Reserves:

American Express as a high-end credit card issuer, shows very good past-due loan percentages, with 30 day past due loans at just 1.4%, versus 1.9% last year. In theory, this low past-due percentage should cause the company to have low loss reserves at the same time. However, that doesn't seem to be what's happening. While American Express decreased loss reserves by 42% year-over-year, as we've seen in all major divisions, the current loss reserves were increased. This should be a concern for investors as companies usually increase their loss reserves when they expect future delinquencies to rise. On a positive note, American Express still maintains reserves of 201% of past due loans.

Innovations:

In today's credit card market, innovation is key, and American Express is not resting on its brand name. The company has developed a Twitter experience where members can use hashtags, and get savings loaded directly onto their cards. When the member uses their card on qualifying purchases, the savings are credited to the statement within days. Additionally, card members and merchants are going to have first access to Twitter's new advertising solution for small businesses. American Express also is rolling out its prepaid card which is re-loadable, with both no monthly fees or maintenance fees. This card is expected to be available at more than 1,100 Office Depot stores.

Competition:

Even with these innovations, American Express still faces a tough challenge in the marketplace. Companies like Visa (NYSE: V) and MasterCard (NYSE: MA) have the advantage of being more widely accepted in the market. This is due to the fact that most merchants pay a lower discount rate by accepting Visa or MasterCard, than they do if they accept American Express. By point of comparison, a merchant might pay between 1-2% in interchange fees with Visa or MasterCard, but it's not unusual to see rates of 2-3% to accept American Express. With the economy still uncertain, many businesses aren't willing to pay up to get more American Express users in the door. Visa is expected to grow at over 19% per year, and MasterCard is expecting similar growth. It seems American Express is being left behind, with just 10% EPS growth expected in the next few years. Another challenge that American Express faces is more merchants are willing to co-brand their store card with Visa or MasterCard because of the wider acceptance. Even a company like Discover Financial Services (NYSE: DFS) which has similar acceptance, poses a real challenge to American Express. Discover not only offers cash back with each card, but most Discover cards do not charge an annual fee. A standard feature of a basic American Express card is an annual fee. More and more consumers are being educated against signing up for a credit card with an annual fee, which is a negative against the company. Many merchant providers offer the ability to accept Discover along with Visa and MasterCard. While Discover usually charges a higher interchange fee, the combined statement and support is a benefit that American Express can't offer. 

Conclusion:

While American Express is a well-known name in the marketplace, the company is going to need to do more to offset the various challenges of these other card issuers. In the old days, American Express used to advertise "membership has its privileges". However, other card issuers have benefits that are very similar to a basic American Express account. The main challenge American Express faces in the future, is the acceptance of its cards at merchants. To be blunt, the company needs to find a way to convince merchants that they need to accept American Express even if the fees to do so are more expensive. The industry is changing as well and the “big 4” card issuers are not the only game in town anymore. With companies such as Home Depot, connecting with payment solutions like PayPal, American Express could become a less popular option for merchants to accept. An American Express card is no longer the status symbol that it used to be. While the current quarters earnings numbers are impressive, it just seems that there are better options available. With greater acceptability, and greater expected earnings growth in the future, I would suggest that Visa or MasterCard provide a better opportunity for investors at this time.

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