AXP Stock Analysis

By: EBS Invests 

Overview:

American Express Company (AXP) is Warren Buffett's 3rd largest holding by weight in his portfolio; it also happens to be one of my largest holdings. American Express is not your normal credit card company. They’re also a bank and offers a closed-loop system of payment, which is very different from Visa (V) or MasterCard (MA).

AXP, along with its subsidiaries, is divided into three main revenue streams. They include global consumer services, global commercial services, and global merchant and network services. Between the three, they offer credit card payments, card products, and worldwide travel products. They also include financing products, network services, and other smaller services.

This may sound like your V or MA card; however, AmEx does not deal with mass card issuance. AmEx only targets the top 10% of Americans, and it shows. Between V and MA, they represent 84.4% of all cards in circulation; AXP falls in at 7.5%. You may be thinking that's awful. Why would I want to own a company with only a single-digit market share? To answer that, in 2022 Visa and MasterCard revenue combined brought in a total of ~$48.1 billion; American Express overshadowed them at ~$50.6 billion with fewer cards and a smaller network.

Part of the reason AXP is so profitable and popular is because they charge fees to use their card, higher fees for merchants, and higher interest rate fees. However, because AmEx targets wealthy Americans, many pay the fees for premium cards like platinum or gold cards for their great benefits. No other card issuer comes close to their customer service, products, and offerings.

Adding to this is AmEx's closed-loop system. They are the only major card issuers who do this. The best explanation I found is from Forbes, detailed here: "AmEx issues its cards through its banking subsidiaries, American Express Centurion Bank and American Express Bank, FSB, and employs a closed-loop network, acting as both the issuer and acquirer. The company's primary source of revenue is the discount fee charged to merchants who accept its cards. These fees are charged as a percentage of the charge amount processed for the merchant and account for 65% of the company's revenues. AmEx also earns interest on loans issued to cardholders, membership fees from its cardholders, and other revenues based on travel services offered. However, its revenue model does not depend on the volume of transactions processed but rather on the total amount spent by the customer.”

Thus, when you target the wealthiest people on the planet, you’re not concerned about how many cards you issue to get volume; you just want your customers to spend more. Typically, wealthy customers spend 2.4 times more than poorer customers. Furthermore, due to the closed-loop system, AmEx can use data from their cardholders to see what they’re buying and offer incentives to spend more. As the world becomes more wealthy and growing countries see them as a premium brand, they’re well poised for more growth than they are already expecting.

Examples of this growing worldwide wealth can be seen in Australia. Where AmEx plans to on-board thousands of new merchants in 2024, and grow their card base internationally. Increasing the amount spent and allowing for more organic growth with the firm.

Financials and dividend information: ^_**

AXP is a real compounder; it has a 5-year revenue-compound annual growth rate (CAGR) of 9.17% and a 3-year CAGR of 17.19%. Furthermore, they boast earnings per share with a 5-year CAGR of 11.84% and a 3-year CAGR of 36.25%. For a company that has a market cap of ~$135 billion.

AmEx is a free cash flow producer; it had a 2022 free cash flow (FCF) margin of 37.93%, a 5-year net profit margin of ~15.7%, and a gross profit margin of 56.8%. Showing strong cash flow production, profitability, and ability to pay off debts.

Dividend growth is one strong reason why I'm a big fan of this stock. The firm has a 5 dividend-year CAGR of 11.78%. Recently, AXP has bumped the dividend by 20% and 15% over the past two years (dividend increases stalled in 2020 and 2021 due to uncertainty in Covid). The dividend now sits at $2.40 per share, with a yield of 1.3%. The payout ratio is 22.49%. Showing that AXP can very healthily sustain their dividend and offer higher and higher raises without impeding the free cash flow of the company.

Moat Review:

In the competitive realm of financial services, American Express's moat distinguishes itself from rivals like Visa and MasterCard. American Express targets an upscale demographic, with its Platinum and Centurion cards renowned for premium perks and exclusive services. Despite Visa and MasterCard's broader global acceptance, American Express prioritizes brand loyalty, catering to a more affluent clientele. While this strategy may lead to lower transaction volumes compared to its competitors, it fortifies a resilient moat. American Express boasts a higher average spending per cardholder, emphasizing the brand's appeal to high-value customers. This, coupled with its strategic partnerships and innovative offerings, positions American Express as a distinctive and formidable force in the financial services industry.

Morning Star moat rating: Wide

Valuation: 

AXP currently trades at a price-to-earnings ratio (PE) of ~17.34, below my maximum threshold of 25. It also trades below V at 31.95 and MA at 37.31. Comparing PE, they’re the most undervalued option. In terms of price-to-book (PB), AXP is expensive at 4.93 but is down from its high of 5.71. AXP also has a decreasing debt-to-equity ratio, sitting at 1.76, down from 2.79 five years ago. Furthermore, they boast a very nice price-to-cash flow ratio of 7.26, showing cheap shares on the price-to-fcf side of things. AmEx, per some of these metrics, shows that they’re slightly trading below normal, showing undervaluation.

As Gen Z customers come to love them, and as their products grow in popularity in other countries, the company continues to issue guidance for 13%–15% revenue growth in 2024 and earnings per share growth of 15%. In Q3 of FY23, AXP reported in line with guidance and continues to issue bullish growth going forward.

Adjusting this into my intrinsic value model, I applied a more conservative PE no-growth of 7 (typically 8). Due to tightening credit conditions and growing debt among Americans. I also applied a lower growth multiplier of 1.5 (typical is 2). To allow for more accurate calculations and help price macroeconomic factors not present in the data. Furthermore, I applied an 11% growth rate, below the 13–15% target, for extra caution.

With the data above, I get an intrinsic value of $233 and a maximum buy price of $186 with a 20% margin of safety. I find this stock to be undervalued. Analysts at 3 different firms have their price targets at the following: CFRA price target of $205, Arugus price target of $200, and Morning Star price target of $178. Averaging between mine and theirs, I get a combined value of $204. I would try to target a maximum buy price of anything under $175 to allow for a margin of safety and potential. If you can grab AXP below $165 as I did, you have found yourself a bargain.

Risk’s: 

Risks to be aware of for AXP “Include that higher-than-expected net charge-offs and delinquencies are leading to more provisional expenses, intensifying competition. Leading to higher rewards and marketing expenses. Further a decrease in consumer spending and loan balances (CFRA).” One thing to note is that they have the lowest delinquency, and charge-off rate in the industry by far. Furthermore, that rate has been decreasing since peaking in 2021.

In Q2 2023, AmEx announced they had 1.2 billion in provisional credit card losses. Compared to 410 million a year ago, Showing higher net write-offs and consumers defaulting on their credit cards.

Furthermore, American credit card debt has reached an all-time high of $1.08 trillion, last peaking in 2008 during the recession. AXP has less risk with this, as their customers are wealthier, leading to less pressure on inflationary environments, and can pay off cards. Moreover, as inflation goes down and prices stabilize, more consumer spending will ensue, which is good for them.

AmEx weathered the 2008 financial crisis perfectly fine, only losing $3 billion in annual revenue and growing that by $6 billion the following year. I see risk at this firm above your average company; however, this strong cash flow production and balance sheet should weather any storm.

One thing I did notice that concerned me is that they have decreasing gross profit margin, as the company continues to spend on operating costs and marketing. They did announce they will slow marketing spending, stabilizing at ~5.5 billion a year, and only increase at a rate of 1.5% maximum per year; thus, with revenue growth, it will not be noticeable. Furthermore, the firm is aware of its drop off in profitability margins and plans on streamlining the business to increase the margin. That is another risk to be aware of; however, I believe AmEx will cut costs and increase operating costs slightly each year.

Moreover, another risk is the Basel III Endgame. Following the fallout of the 2023 banking collapse, lawmakers are trying to impose new regulations on the banking industry. The change will affect minimum reserve requirements and capital requirements. According to JPMorgan's CEO, Jamie Dimon, he believes it will make bank stocks "not investable." From a banking standpoint, Basel III endgame refers to the final implementation of international banking regulations aimed at strengthening the banking sector's resilience and stability. It introduces higher capital requirements, liquidity standards, and risk management practices. While enhancing financial system robustness, it may impact banking stocks by increasing compliance costs, potentially leading to reduced profitability.

Currently, Basel III is only set to affect banks with over $100 billion in assets. I bring this up as AXP has well over $100 billion in assets and is technically a bank. The Fed is set to announce Basel III updates in the first half of 2024. The Fed Governor Waller voted against the proposal in July of 2023; he expressed concern that it would “increase the cost of credit and impede market functioning without clear benefits to the resiliency of the financial system (Wessel).” I currently believe that legislation and the power of lobbying will protect banks and investors; even the Fed is not on board with the idea. Basel III stems from a democratic party push for more regulation; however, with elections in the fall, this could grind to a halt. It's something we investors do need to be aware of though.

Conclusion:

I do believe AXP to be one of the best stocks you can own with a wide moat. However, if gross margins fall below 40%, I will have to sell out, but where it stands at ~57%, it’s still a very profitable and healthy company. I generally only buy companies with margins above 40%, so I see the problem as minor.

The firm is a distinctive force in the financial services sector, strategically blending credit card services with a closed-loop system that specifically targets the affluent demographic. Unlike competitors Visa and MasterCard, American Express’s focused approach caters exclusively to the top 10% of Americans, resulting in a smaller market share but higher profitability. The company's success is underpinned by its unique business model, charging higher fees, offering premium card products, and leveraging a closed-loop system to provide personalized incentives based on customer spending data.

Financially, AXP demonstrates robust growth with noteworthy compound annual growth rates in revenue and earnings per share. Strong free cash flow margins, profitability metrics, and consistent dividend growth further contribute to its investment appeal. Despite being undervalued compared to industry peers, AXP faces inherent risks such as potential charge-offs, delinquencies, and the ever-present challenge of heightened competition.

Their moat underscores AXP's resilience in the competitive financial landscape. With its wide moat, the company distinguishes itself by targeting a wealthier demographic, offering exclusive perks and services that foster strong brand loyalty. While Visa and MasterCard boast broader global acceptance, AXP prioritizes quality over quantity, emphasizing its appeal to high-value customers. This moat, coupled with strategic partnerships and innovative offerings, positions AXP as a formidable player in the industry.

Valuation metrics further support the investment case for AXP. Trading at a price-to-earnings ratio below industry thresholds and exhibiting undervaluation in various metrics, the company offers an attractive proposition for investors. As Gen Z customers increasingly embrace AmEx, the company foresees sustained growth in revenue and earnings.

While risks, including consumer spending fluctuations and potential regulatory changes, must be acknowledged, AXP's unique strengths and financial resilience make it a compelling investment option.

^{*AXP’s next earnings are set for January 26th. Keep an eye on how the stock does for this quarter and the guidance they issue. Research reports on this stock and many others are available by emailing me.}

Further resources regarding AXP :

Stock purchases and dividends, Jan 1-Jan 14:

Purchases:

• AVUV - 3x

• SBUX - $26

• SCHD - 5x

• SCHG - 5x

• XLV - 2x

Dividends:

• ALB - $0.62

• LRCX - $0.88

• SCHG - $0.35

• TROW - $5.37

  Total in period (1/1-1/14): $7.22

  YTD Total: $7.22

  Life Total: $449.22

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EBS Invests 2023//

NOT A FINANCIAL ADVISOR.

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