American Express is a pillar of consumer finance. Many may not be aware that its invention of the Traveler Cheque in 1891 was instrumental in facilitating the spread of global commerce in the 20^th century. Many may also be unaware that Lehman Brothers was formerly the investment banking arm of American Express. All this history isn’t just window dressing. At roughly $25 bn, AXP possesses the 28^th most valuable brand in the world and the second most valuable financial services brand in the world, behind only Visa. If you’re not familiar with the company, it has a history of being very travel adjacent in terms of rewards and benefits to customers, and thus it has underperformed competitors during the pandemic. The company was famously one of Warren Buffett’s significant early investments in 1964. He now owns northward of 7% of the storied company. Not a bad guy to have keeping management on its best foot forward on your behalf.  

Source: Tipranks.com

American Express has more affluent customers than most in the card business. It has had 200% to 400% higher average cardmember spending than Visa and Mastercard in regular times.  Despite this, the enmeshment with the travel industry has been hurting revenues lately. AXP has crucial brand partnerships that feed volume with British Airways, Marriott, Hilton, and Delta, the last of which constitutes 8% of worldwide billed businesses and more than a fifth of Global Cardmember loans. So, travel had been a significant weakness. As it is accelerating and what can only be described as a travel-mania (and we mean the convergence of simultaneous demand, not valuations of travel stocks) grips the post-pandemic economy, we believe this name will thrive.

Their spend-centric model has hurt them revenue-wise in the leanest of times in travel’s history, they were down 12% YoY in Q1 earnings, but this business model also allows them to earn 4x to 8x more per transaction than their competitors so when travel-centric volume booms in coming months the company will prosper. Our Head of Portfolio Strategy, Brian Rauscher, has seen positive work on the company in his time-tested Earnings Revision Model (ERM) as well. We believe the recent performance in lagging peers is about to reverse. COVID-19 has been hard on the firm, but it has also capitalized in some ways from the growing use of cards which should fuel higher growth in foreign markets where card use is lower.

Souce: Seekingalpha.com

Old-Name, Closed-Loop, Big Data, and Improvements Under The Hood

This company can trace its roots back to 1850 and its roots in financial services to 1857. So, you may think this is a boring name owned by old investors. Yes, it is, in a way. It’s a stalwart Dow component that institutional investors love. This is why we are optimistic about the price action when the company likely starts outperforming earnings expectations. When and if it becomes apparent that American Express is better positioned to capitalize on the coming travel bonanza than any of its competitors, we think money will flow into the stock. We think then the divergence in performance reverses. The capacity for upside surprise on earnings is very significant here, and that appears to be reflected in activity among the sell-side analysts covering the name.

Source: Fundstrat, Bloomberg

We like other competitive advantages as well. The company is a closed-loop network in the United States, meaning it is the issuing bank, the network provider, and the acquiring bank. This gives it an immense advantage in cross-selling, not to mention all the fees, and an acute understanding of the needs of its customers gleaned from this considerable data advantage. We think the ultra-cyclicality experienced in the travel industry will soon be a major asset that will bring relatively explosive growth and rewards to shareholders. US volumes significantly exceeded expectations in Q1. Spending in March from US small and medium enterprise customers was higher than March 2019 levels! Under the disappointing 12% revenue drop in Q1 that is primarily driven by continued weakness in T&E by businesses was an incredible 35.98% QoQ increase in EPS after two previous significant sequential increases. Buying this stock before T&E fully recovers will probably prove advantageous. As Barry Diller said in a recent interview on CNBC, “There are people saying travel won’t come back. Those people are dopes.”

Source: Company Reports

Prospects For Travel Rapidly Improving, American Express Well Positioned

Jefferies U.S. economics teams put out estimates that they thought US households had accumulated $2.2 trillion and that the majority of this glut of cash is concentrated in the hands of high-earners. These are the very same earners that are more likely to be American   cardholders. To illustrate the sheer strength of the companies business model we point attention to the fact that despite having only 5% of cards in force AXP accounted for 20% of total purchase volume out of the Visa, Mastercard, Amex, and Discover. When the scriptural torrent of travel demand gets released, American Express, a seasoned and time-tested company with a delicate and active management of its relationship with customers and merchants, will probably be better positioned to capitalize than any other financial services company. What do you think the effect on that number will be when an inordinate amount of the affluent consumer’s wallet is dedicated to travel?

Also, whereas credit card spending has declined across lower income levels as consumers used their payments to become less reliant on revolving credit and more focused on saving and investing, American Express volume is down more because of COVID-19 reasons. Rich people spend on credit cards as a matter of convenience, and we don’t anticipate the same dynamic that will affect their competitors affecting them. Their credit book and balance sheet have the best quality among peers. This fact can be seen in their borrowing costs compared to their peers. This already fiercely competitive company also, in true Epicenter fashion, increased its Operating Profit Margin by almost 40% on a QoQ basis. Things are moving in the right direction for this financial juggernaut. Default rates are down across the board as well, and a cadre of improving consumers will likely prove fertile ground for American Express’s suite of competitive products that are loved by millions of affluent and middle-class customers across America and the world.  

Source: Fundstrat, Bloomberg

A Closer Look At What Drives AMEX

The company reports three segments Global Consumer Services, which is about 56% of revenue, Global Commercial Services, which is about 26% and Merchant & Network Services, at 18%. Within the most significant segment, growth and profitability are functions of growth in the US and International Card Transaction Volume and the percentage of proprietary card income constituted by fees. The general trend in card use has been positive. Consumers are generally moving away from cash and toward plastic. American Express should actually benefit significantly over time as the American consumer’s balance sheet clears up and their affluence increases. The company has already made major progress in the last quarters at attracting new accounts. This was part of the source of their outperformance and we expect them to continue progress here as they utilize their impressive brand and data advantages to the benefit of shareholders.

Source: Company Reports

American Express has also been focusing on getting more merchants and retailers within their network. One of the more notorious aspects of the business is that in exchange for bringing its more affluent big-spending customers to businesses it charges a higher average discount rate, roughly a third higher than the industry average. The quirk of the business model is something management wants to correct, howver again here, this proves how the company can often punch above its weight. Discover has significantly more retailers accepting their cards, but American Express still is third among the four processes in volume despite having significantly less merchants accepting. However, the upside here is appealing and the efforts of the company are likely to be fruitful. So, again, there is a lot that we like going on at this company. We think a volume based business that is exposed to travel and has leveraged returns per transaction compared to competitors is going to do quite well in the coming quarters.

Risks And Where We Could Be Wrong

There are two primary dimensions of risk of here. One is along the competitive dimension. There are major innovations occurring in the space of payments and consumer credit. FinTech companies could emerge that seriously undermine the competitive advantages or volume of American Express. However, part of the reason we like this company is because we think it is better insulated from this risk than Mastercard, Visa or Discover because of its unique spend-centric business model and reliance on higher spending, more affluent customers and a masterful track record with enticing rewards. We also think that the company’s data advantage from its closed-end business model provides some degree of a moat from competitors, although this is also enjoyed by competitors Visa and Mastercard with their gigantic network effects. However, being third in a market dominated by a duopoly can often result in growth at the big guys expense. We suspect this happens as the travelmania of the roaring twenties develops!

The main risk for this company is that we have seen manifest over the last quarters and the company has emerged with flying colors. It still has a strong balance sheet and its capital levels in many cases exceed its targets. Nonetheless, the company does have a lot of international exposure and as the pandemic ricochets across the globe growth initiatives in certain markets could be suspended or rendered ineffective. However, the bulk of revenue does come from the United States. Any rise of variants or continued prevalence of the pandemic and its negative effect particularly on travel and international movement will negatively effect the company more than its peers. The thesis for AXP is largely contingent upon travel recovering to a considerable degree. Another risk is that business travel never recovers to previous levels. However business T&E is a major carrot and may be an appealing lever to help ease folks back into the office. We hope so!