Don't Ignore this Premium Asset
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If American Express (NYSE: AXP) were actually a commercial bank, it would rank among the country's fifteen largest by assets with just over $150 billion. It is classified as a bank for FDIC purposes, but what it really is, of course, is a premium provider of credit and conveniences to high net worth individuals and businesses. As such, it was largely shielded from making the sort of loan loss provisions that impacted its similarly sized banking peers. And, as the wealthy discovered that the sky was not falling, the company has been highly profitable these past few years on the backs of increased spending by its customers. But amidst renewed uncertainty both in America and in Europe even those customers have been reigning in their spending, sending American Express to a relatively disappointing second quarter of 2012.
For the quarter, American Express earned $1.34 billion, compared with last year's second quarter $1.33 billion. Earnings per share advanced to $1.15 from $1.10 a year earlier, due to fewer shares outstanding. Revenue, net of interest expense, came to $7.97 billion up 4.6% from the $7.62 billion year earlier quarter. Adding to the generalized flatness of the quarter was the utterly unexceptional income statement. All major categories, such as interest income, non-interest income, and non-interest expenses, were within a few percentage points of each other.
Much news coverage has been devoted of late about whether American Express had agreed to take part in the Google (NASDAQ: GOOG) Wallet. On August 1, Google released a report strongly implying that such an agreement had been reached. Two days later Google recanted on American Express' agreement on the project. Eventually, I am quite certain an agreement will be reached with Google, which is probably more valuable an issue for Google than it is for American Express at this time.
The new Consumer Financial Protection Bureau has seemingly targeted the credit card industry for negligent practices in its customer dealings, in areas such as rewards programs, returns, and refunds. Capital One (NYSE: COF) has already been fined $210 million in these issues, and Discover (NYSE: DFS) and Bank of America (BAC) are also under investigation.
Now for the big issue. I believe the biggest, by far, macroeconomic issue in this country is the gap between high income and low income individuals, which has been expanding since the 1970’s. This has occurred in no small part due to tax changes. In the upcoming elections, if Obama is reelected, I anticipate some scaling back in the tax rates that have helped to spur this income gap. If Obama is defeated, I am certain that the income gap will be exacerbated. This plays into American Express's markets. It is the largest credit issuer by sales volume in this country, and caters to the upper income class almost exclusively. If tax law allows upper income individuals to keep even more of their earnings, it will be a good day indeed for American Express.
American Express pays a modest 1.4% yield, but also in the middle of a massive, $5 billion share buyback. It has exceeded analysts’ expectations each of the past four quarters, and I am looking for 2012 earnings of $4.50 per share, giving it a price to earnings ratio of about 13, and a five year PEG of about 1.1. Insiders such as Warren Buffett, who has owned American Express since 1964 and Ken Fisher have large positions in the company, and I regard American Express as a top tier, buy and hold candidate.
Visa (NYSE: V) has had a tumultuous summer. Its second quarter was a disaster as it suffered from an over $4 billion charge in settlement of antitrust litigation. If one takes away that one time event, along with several much smaller one time credits, Visa reported second quarter non-GAAP earnings of $1.1 billion, or $1.56 per share. This was an advance of about 9% from the $1.43 of the second quarter of last year, and beat analysts' expectations in the quarter of $1.45 per share. The gains were revenue driven, as revenues were up about 10% on a year over year level, to $2.56 billion.
It is a huge plus for Visa to finally have resolved this now 7 year old antitrust issue. Otherwise, similar suits await the company in Europe, and the domestic settlement should provide a sort of template for the resolution of that matter.
Looking beyond the litigation, Visa is a hugely profitable and secure company. It does not issue credit, but rather is the world's largest payment processor. As time goes on, cash will slowly but surely give way to more and more electronic payments, and Visa's growth is all but insured. The company is looking for growth in the low 20% range this year, and expects to buy $1 billion of its stock back by summer of 2013.
Visa's expensive price to earnings multiple is matched by an anticipated high level of 5 year growth, allowing a 5 year PEG of 1.1. Still, the stock is less than two percent off its 52-week high, and I would like to see more of a dip in price before committing to Visa, but it is a winning company and suitable for a buy and hold situation.
Capital One's earnings of late have been held down by one-time costs related to acquisitions, the most recent one of which was the $31 billion dollar purchase of HSBC America's credit card business, which came on the heels of Capital One's $9 billion purchase of ING's American portfolio, which was its online bank. Large European banks have been forced to sell non-core North American business to raise capital, and I believe Capital One made both these acquisitions at attractive price points. The meager results of the second quarter were forced mostly by a large, $1.67 billion loan loss reserve set up to account for weakness in segments of the HSBC portfolio.
Since the bulk of Capital One's portfolio is in credit cards, its net interest margin, while down, is still just over six percent, far larger than any traditional commercial bank. Looking forward, this company has greatly enhanced its growth potential by its acquisitions, and I look for a bright two years for the company. I do not see the same kind of buy and hold potential that I see in American Express or Visa, but Capital One's reasonable current valuation leads me to conclude that this company will outperform the market at least for the next eighteen months, if not beyond.
StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Google and has the following options: short OCT 2012 $55.00 puts on American Express Company, short OCT 2012 $60.00 calls on American Express Company, and long OCT 2012 $65.00 calls on American Express Company. Motley Fool newsletter services recommend American Express Company, Google, and Visa. 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.If you have questions about this post or the Fool’s blog network, click here for information.