Consumer Borrowing Is up, Stick to These High-End Players

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

“Consumer borrowing in the U.S. climbed in May by the most in a year,” according to Bloomberg. Credit cards, school loans, and automobile loans led the list. While increased spending, particularly using debt, is a good sign, rising rates could materially alter this trend. Stick to higher-end players like American Express (NYSE: AXP) and Toll Brothers (NYSE: TOL).

Spending Again

Americans appear to be spending again. That's a good sign since consumer spending makes up around 70% of gross domestic product. The housing market finally starting to pick up, a resilient stock market, and an improving employment picture have all helped push people to start taking advantage of the historically low interest rate environment.

However, rising rates have also spurred people to act while low rates are still available. That has likely pulled some big ticket sales from the future into today's numbers. If rates keep heading higher, there's likely to be a tipping point where growth stalls because debt costs become a hindrance to spending. If we hit that wall, some of the companies benefiting today could see results turn quickly lower.

Higher end consumers, however, have managed the recession and weak recovery much better than less affluent consumers. So the best way to play the improvement in consumer spending is to stick to companies serving those with the wherewithal to keep spending even if rates move higher.

Not Your Average Card

The best way to describe American Express is to call it the credit card for rich people. It's built an impressive reputation on customer service and exclusivity. Although it's been branching out to reach more consumers, it remains focused around high-end clientele. Such customers earn more, spend more, and pay their bills more reliably than the lower strata.

The strength of the company's core customers was on display during the 2007 to 2009 recession. Competitor MasterCard (NYSE: MA) lost almost $2 a share in 2008. The lowest American Express' earnings fell was to $1.50 or so a share in 2009.

Although MasterCard is a great business, that swift fall was the result of customers reigning in their spending at the same time as weaker borrowers were defaulting. American Express' customer base is simply of a higher caliber. MasterCard's bottom-line has advanced quickly since that low, reaching nearly $22 a share last year, but it is also trading near all-time highs with a price to earnings ratio of about 26. If earnings stall, the shares could fall quickly.

American Express is also trading near its highs, but has a PE of around 19 and a historically more resilient business model. Growth investors looking for a way to tap into the growing appetite for credit cards should look at American Express over MasterCard or similarly situated Visa.

Recovering Home Market

Big ticket items like cars and homes are also in increasing demand. However, the spending here is far more reliant on interest rates than consumer spending on credit cards. From that perspective, investors should be focusing on home builders that cater to the buyers most capable of paying more to buy a home. That means the high end.

Toll Brothers focuses on exactly that segment, selling single family and attached homes in luxury development complexes. The company's sales fell 75% between 2006 and 2011. That was a brutal period for all home builders. Like its brethren, Toll used the downturn to streamline its business. Those efforts bore fruit relatively quickly, since it was able to earn nearly $0.25 a share in 2011 despite the 75% revenue drop.

The company has seen demand increase of late. In the second quarter, deliveries advanced 38% year over year, new sales were up 57% in dollar terms, and the average selling price was $678,000 in the second quarter, up from $585,000 a year earlier. Backlog, meanwhile, was up 69% in dollar terms. In fact, the company has seen year over year sales growth in each of the last five quarters.

On better financial footing today than before the recession and catering to buyers who remain in good financial health, Toll is probably one of the better home builders right now. Even if less affluent customers are forced to pull back, Toll should continue to see relatively strong results.

Pulling it Forward

While pent up demand has probably helped push consumers to spend more, low interest rates have clearly helped, too. With rates heading higher, Toll and American Express are better positioned than most of their competitors to handle a spending downturn since their customers make more, spend more, and weathered the 2007 to 2009 recession better.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends American Express and MasterCard. The Motley Fool owns shares of MasterCard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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