American Express Stock Analysis & Deep Dive

The premium payment company

Aug 06, 2023

Intro

Next to the behemoths Visa and Mastercard, Amercian Express (Amex) is the third big payment company. While Visa and Mastercard’s shares go hand in hand and have been astonishing long-term investments, American Express has been lagging behind. This begs the question: Is American Express a good investment as of today?

The Company

American Express is a leading credit and charge card issuer to both consumers and businesses. I am sure most of you have seen the famous green or black American Express cards. Fun side fact: You cannot apply for the black card. The black card, also known as Centurion Card is invitation only and rumors are that you need to spend at least $100-250k a year to be eligible for the invitation.

Amex was founded in 1850 as an express mail dispatcher and pivoted to financial services in the early 1900s. It is based in New York, employs 77.000 people and is one of the 30 members of the Dow Jones 30, which it joined in 1982. The company has a rich history and used to have very cool paper based stock certificates as the one from 1865 shows below:

American Express is one of the most valuable brands in the world, ranking 63rd in 2022 ahead of Visa, Ford, Louis Vuitton and Nestlé.

The Industry

As seen in the long-term stock chart above, the incumbents of the industry are doing very well. Visa is clearly leading the pack in terms of purchase volume. Mastercard and American Express are number 2 and 3 in terms of purchase volume.

All of the payment providers have an inbuilt inflation protection: When prices go up, so does the share in absolute numbers, which the payment processors take as a fee. To quote the CEO from the Q2/23 earnings call: “And you have to remember, and, you know, you guys all know this, this is a very good industry to be in.”

The global payment processing market is expected to grow with a CAGR of 12% in the next 10 years. Further growth in e-commerce share will add to the underlying growth trends. Covid as also accelerated the acceptance of payment by credit card in comparison to cash.

The Business

Amex business is centered around its own transaction network.

There are 122m American Express cards in circulation, of which 56m are based in the US. The average cardholder spends $23k with the Amex card per year (!). The goal is to be the leading premium card issuer with an attractive value proposition for its users and partners. Due to the annual fees, customers are more likely to make purchases with their Amex card in order to get the benefits of their Amex.

The company is split into 4 segments: U.S. Consumer Services (USCS), Commercial Services (CS), International Card Services (ICS) and Global Merchant and Network Services (GMNS).

Card Issuing Businesses

The goal is to acquire and retain high spending and credit worthy card holders through cash-backs, partner relationship and dedicated customer service. One of the focus points is to attract more Millennials and Gen Z clients. In 2022 there were 76.7m proprietary cards in circulation. Amex charges high annual fees for its cards. For example the Platinum card costs 695$ a year and gives multiple benefits, as shown in the picture below.

Global Merchant and Network Services (GMNS)

The main goal is to manage existing merchants and sign new merchants to accept Amex cards as a method of payment. Merchants sign individual discount rates and are being offered fraud-prevention, marketing solutions and data analytic insights into their customers.

Card Network Business

Amex runs its own card network. Third party banks and other institutions in 103 countries are part of it and can issue Amex branded cards in the local currency. In 2022 there were 56.5m cards issued by third parties in circulation and the total spend from these cards was $214bn. The most important partner is Delta Airlines and co-branded cards between Delta and Amex represent 10% of the global network volume. As part of this relationship, Amex customers have large benefits when using Delta services, such as airport lounge access for certain card members.

American Express converted into a bank holding in the financial crisis in 2008 and therefore falls under banking regulation. The effective minimum for the common equity tier 1 ratio is 7% and Amex strives to stay between 10 and 11%. The common equity tier 1 is made of liquid holdings such as cash and stock. The plan of Amex is to distribute excess capital to shareholders in the form of dividends and share buybacks. In 2022 $4.9bn were returned to shareholders with 1.6bn in dividends and 3.3bn in share repurchases.

The Management

Berkshire Hathaway is the largest shareholder in American Express with 20.4% of all outstanding shares. After Apple and Bank of American, American Express is the third largest holding of Berkshire Hathaway. Since Warren Buffett and Charlie Munger have a strong focus on capable managers with high integrity, I am happy that they are invested. The first purchase of American Express shares by Berkshire was made in 1963, when Amex got caught in the so called salad-oil-scandal and the shares fell by more than 50%. Buffett used the chance to buy 5% of the company for just $20m and followed up in 1991 to buy another $300m in shares of Amex. Trough continuous share buyback programs, the share which Berkshire Hathaway owns of Amex keeps increasing.

Stephen Squeri joined American Express in 1985 and became the CEO in 2018 after the previous CEO retired. He holds 198k shares in Amex worth $33m.

Christophe Le Caillec will become the new CFO on August 14th while current CFO Jeff Campbell will transition into a vice chairman role after being the CFO for 10 years. Christophe Le Caillec has been with American Express for more than 25 years. This is a very stable management team and I like it!

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Risks

The largest risk lies in a deteriorating economic environment. If more consumers default on their outstanding loans, Amex has to write those loans off.

Other risks include newcomers in the financial world such as Block and Stripe, but so far the three incumbents in Visa, Mastercard and American Express hold onto their reign.

The Fundamentals

The business is growing nicely and especially the Millennials and Gen-Z cohorts show strong growth and make up over 60% of new consumer accounts.

On the rising interest rates

Unlike a classic bank which makes money of the difference in interest rates charged and received, American Express saw some headwinds from the rising interest rate. Most cards are charge-credit cards. That means the consumer has a free credit line, which he can use and pay down the open amount at the end of the month. This credit facility is financed by American Express and therefore, Amex experiences some headwinds. Here are comments from the most recent earnings calls:

Q3/22: “While, generally speaking, a rising rate environment would be a modest headwind for us due to our sizable noninterest bearing charge balances, in actual fact, it has been fairly neutral in terms of impact for us year to date.”

Q4/22: “The rising interest rate environment has had a fairly neutral impact on our results in '22 as deposit betas lagged the rapid and steep benchmark rate increases during the year. However, when you think about 2023, deposit betas are now in line with more historical levels. So, I would expect the year-over-year impact from rising rates to represent more of a headwind in 2023.”

Q1/23: “When you think about headwinds in 2023, I’d remind you on the January call, I pointed out that a 500 basis point increase in interest rates in a year is a headwind for us year-over-year in 2023, which won’t really exist in 2024.And they’re unlikely to do another 500 basis points.”

Revenue breakdown

So how does Amex make money? Here is the breakdown of the revenue:

Discount revenue (the fees Amex gets from the merchants to facilitate the payment) is the largest revenue position.
Net card fees are the annual fees paid by the card holders (e.g. 695$ p.a. for the Platinum card).
Service fees are made from merchants, travel commissions, delinquency fees and FX related fees.
Processed revenues represents the royalties and fees earned for facilitating transaction on the Amex network by network partners.
The interest income is made from outstanding loans balances.

Credit Losses

If a customer defaults on the loan taken from Amex, that amount has to be written of and is recognized as a loss. Depending on the economic environment, Amex has to increase reserves for credit losses (economy weakens) or can release reserves (economy strengthens). For example in 2021, the rebounding economy after the initial Covid shock led to a release (profit) of credit loss reserves. Since Amex is a premium offer, the consumers tend to have a better risk profile and higher credit scores (e.g. Fico) than the average credit card customer.

Expenses

The largest expense contributor are card member rewards, which consist of membership rewards and cash back expenses. Business development expenses are made of partner payments and client incentives.

Amex revenue has been steadily increasing in the last years:

Net income and Free cash flow have been rising as well

And as a result, the dividend per share has been increasing steadily:

While the current dividend yield of 1.45% is not outstanding, read what Warren Buffett wrote in the 2022 Berkshire Hathaway shareholder letter.

“American Express is much the same story. Berkshire’s purchases of Amex were essentially completed in 1995 and, coincidentally, also cost $1.3 billion. Annual dividends received from this investment have grown from $41 million to $302 million. Those checks, too, seem highly likely to increase.”

Through the power of compounding, the dividend received from Amex is now 23% of what Buffett paid for his stake in Amex.

American Express has been reducing the number of outstanding shares steadily. This leads to a strong increase in EPS and free cash flow per share since the created income is distributed among less shares. Amex has reduced the outstanding share count by 30% in the last 10 years. By doing so, the EPS went from $4.88 to $9.85 (+102%) even though the net income itself “only” went up by 40%.

Valuation

American Express is currently trading at a P/E ratio of 16.8 and a forward P/E of 13.5. The historical average P/E is 19. Amex plans to increase revenues >10% in the next years and achieve EPS growth in the mid-teens. With the Q2/23 results, Amex confirmed its 2023 outlook of revenue growth between 15-17% and EPS between $11 and $11.40.

Amex has an EV/FCF ratio of 8.9. Most of the long-term debt is covered by cash and short term investments.

If we assume next years earnings, we have an upside to the historical valuation of 40% and additionally an extra 15% per year from the increased EPS.

Summary

American Express is an interesting company. While not being extremely cheap like some other ideas presented on this blog, it is still a very interesting investment opportunity in a well established company.