American Express Ready to Rise on Stronger Consumer Confidence
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I have heard American Express (NYSE: AXP) referred to as a proxy for the American economy as it is so entwined with a large segment of middle and upper income individuals, and businesses. Just as the economy is recovering gradually, so is the growth in American Express' revenues and earnings.
American Express has certain inherent advantages versus traditional banks. First, its well heeled clientele struggled less in the recessionary years than the population at large, meaning American Express has had lower charge off rates than its peers, and a lower provision for loan loss needs. Furthermore, its cardholders spend heavily and at increasing rates.
In the first quarter of 2012, American Express earnings beat the Street estimates by 7%. Earnings came to $1.3 billion, or $1.07 per share. The per share was a 10% advance from the first quarter of 2011. The earnings gains were revenue based, with revenues net of interest at $7.6 billion, an eight percent jump from the year ago quarter. Expenses rose just four percent, to $5.43 billion.
These revenue gains were brought on by an increase of about 520,000 cards outstanding, and an overall 12% increase in cardholder spending versus the year ago quarter. American Express takes a great deal of pride in its customer service, which no doubt contributes to the increased spending. The commitment to customer service augers well for American Express' future.
The recently concluded first quarter was not an easy period for American Express to show earnings gains. Management described the success as being “spend centric.” Management knew that legal settlements from Visa and MasterCard that benefited the year ago quarter and that the provision for loan loss comparisons, which would not be as favorable as in the past, would impact the quarter. So management went out of its way to ensure expenses stayed under control. The result, of course, was the successful quarter without help from one-time factors.
Looking at that loan loss provision, the quarterly provision rose from a net charge of $97 million in the first quarter of 2011 to a charge of $412 in the first quarter. American Express's loans outstanding have been rising quarter after quarter, so a hike in the loss provision was necessary. It also shows the earnings power the franchise has to overcome this over fourfold increase in the loan loss provision. American Express is well capitalized, to be sure, and among the 19 large banks taken under strict assessment during the Federal Reserve's stress test, it had the third strongest showing after trust banks State Street and Bank of New York Mellon.
American Express' strong capital position has allowed it to raise its dividend for the first time since 2008, to a yield of 1.4%. It also announced a $4 billion share buyback plan for 2012, with another $1 billion slated for 2013. When I last wrote in detail about American Express, its stock was trading in the high forties, and I suggested a price target of $66 by 2013. The company's share price has risen about 25% since early January, 2012, and still has plenty of room to move, to as high as 70, in the next 18 months. Its five year PEG of 1.26 suggest it is neither over nor undervalued at this time. I see American Express as a core, long term holder for nearly every investor.
Capital One Financial (NYSE: COF) is a leading regional bank as well as a provider of Visa and MasterCard branded credit cards. It reported net income in the first quarter of 2012 of $1.4 billion, or $2.72 per share. This was a 37% jump from the year earlier. Earnings were driven in part by Capital One's purchase of ING Direct, which also gave Capital One a one time gain of $594 million. Adjusting for that, earnings in the quarter were $1.56 per share. While these earnings were well below the $2.21 of the first quarter of 2011, at least they beat analysts' expectations of $1.39.
Capital One has been among the many large banks taking advantage of the improving credit climate by lowering reserve provisions substantially each quarter for the past couple years. While the provision fell in the first quarter of 2012 by $288 million over the first quarter of 2011, those days of lowered provisions are going to be over in the foreseeable future. Due to the growth in assets stemming from the ING acquisition, Capital One's ratio of provisions for losses to assets fell a whopping 79 basis points to 2.34% from the fourth quarter of 2011. The company also plans to close on its purchase of HSBC Holdings (NYSE: HBC) domestic credit card portfolio during the second quarter of 2012. There have been warnings Capital One will have substantial costs in acquiring the new portfolio.
It is going to take Capital One a few quarters to digest these massive acquisitions. Analysts have a nearly $2.00 per share gap from the high to the low prognostication for 2012 earnings, an extraordinary gap to be sure. I see indigestion and higher loan loss provisions holding earnings to around $5.70 per share this year, before making a substantial jump toward $8.00 per share in 2013. Do not be scared by a poor second quarter. For the patient investor, Capital One has great appeal.
Discover Financial Services (NYSE: DFS) most recent fiscal quarter ended February 29, 2012. In that fiscal first quarter of 2012, Discover posted earnings of $631 million, or $1.18 per share, which represents a 36% jump from the fiscal first quarter of 2011's $465 million. Loans, revenues, and margins all increased to support that earnings jump. I wonder if Morgan Stanley ponders what would have happened had it not spun off Discover in 2007.
With a 5 year PEG of 0.79, it is difficult to see why Discover is trading at such a discount to its expected growth. The 25 analysts on yahoo finance see earnings actually falling on a sequential basis both in 2012 and 2013. But those same analysts have missed by underestimating Discover's earnings the past six quarters. I see further growth in Discover, and am optimistic that earnings will actually rise a bit each of the next two years before rising more substantially beyond that.
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