Although American Express Co. (AXP, Financial) has recorded 25% revenue growth in the past year, the price momentum for the multinational financial services company is sluggish, especially in comparison to Visa Inc. (V, Financial) and Mastercard Inc. (MA, Financial).
In addition, there is downward pressure on its margins due to the broader macroeconomic conditions.
Regardless, the company's strong reputation and premium brand provide a solid foundation for long-term growth. Additionally, American Express has demonstrated an impressive ability to lock in consumer spending despite macroeconomic challenges, which sets it apart from competitors.
As a result, I believe the market has exaggerated the company's recent issues and failed to consider its resilience to macroeconomic turbulence and robust financial performance.
A competitive edge
American Express operates as a closed-loop system, meaning it manages both the credit and processing of its cards. This model gives the company greater control over the transaction process and offers its customers a range of benefits. By managing both sides of the transaction, it can offer a more streamlined and secure payment process, enhancing the user experience.
One of the key advantages of the closed-loop system is that it allows American Express to establish strong relationships with its customers. By managing the credit and processing of its cards, the company can better understand its customers' spending habits and preferences, which enables it to offer tailored rewards and incentives. This, in turn, helps to build loyalty and encourages customers to continue using American Express cards for their transactions.
In addition, the closed-loop system gives American Express greater control over its fees and revenue streams. By managing the processing of its cards, the company can charge merchants fees for accepting payments. This revenue stream is a key source of income for American Express and helps to offset the costs associated with offering rewards and other benefits to its customers.
How does the operating model stand apart?
American Express maintains its value by being the only provider of premium credit card services with a significant scale. In contrast, Visa and Mastercard, regardless of their divergent business models, prioritize price competition to expand their market share. These competitors primarily measure success through growth in transaction volume, while American Express focuses on high-spending consumers who will increase spending volume metrics.
While Visa and Mastercard offer unique benefits, such as broader acceptance and more affordable options, the company has carved out a niche in the market. American Express has become synonymous with luxury and high-quality customer experiences by offering exclusive rewards, perks and services.
This focus on high-spending consumers also allows American Express to differentiate itself from competitors primarily focused on price competition. Rather than measuring success through transaction volume alone, the company can track metrics related to increased spending by its core customers, which ultimately contributes to its long-term growth and success.
In addition, unlike its competitors, American Express diversifies its revenue streams by generating income from membership fees, interest charges, partnerships and other sources. This diversification allows the company to maintain its position even during periods of decreased transaction volume. Additionally, by not solely relying on transaction fees, American Express is less susceptible to fluctuations in the market and can remain profitable despite economic challenges.
Despite its excellent performance, however, American Express appears to be undervalued compared to its peers based on their respective price-earnings ratios. Currently, American Express' price-earnings ratio stands at 16.97, significantly lower than Visa's earnings multiple of 30.56 and Mastercard's ratio of 34.19.
A low price-earnings ratio suggests the market has not fully recognized a company's earnings potential, and therefore the stock is undervalued. In this case, American Express' relatively lower ratio indicates the market has not fully priced in the potential growth opportunities for the company, despite its solid financial performance.
Expanding the base
While American Express has traditionally focused on providing premium services to high-spending consumers, the company has recently expanded its offerings to include more affordable options for younger customers. With increasing consumer restraint amid inflation and rising interest rates, affordability has become a key factor in customer acquisition.
This strategy has proven to be successful as the company recently reported 12.5 million new card accounts. By offering more accessible options, American Express has reached a broader customer base and appealed to a wider range of consumers.
While this shift toward affordability may seem like a departure from American Express' traditional focus on premium services, it is a strategic move to ensure the company's continued growth and success in a changing market. By expanding its offerings to include more accessible options, American Express can appeal to a wider range of customers and establish itself as a leading player in the financial services industry for years to come.
Generous dividends
I cannot finish this analysis without acknowledging American Express's recent dividend hike and share buyback initiative.
While the company may not be considered a premier dividend stock, it has made significant progress. American Express recently announced a 15% dividend increase and a massive share repurchase program, demonstrating its commitment to giving back in the best way possible.
Some investors may have been concerned about the company's decision not to increase dividends in 2020 and 2021. Still it is essential to note the company has paid dividends for over 30 years and did not cut dividends even during the worst times for its industry, such as the 2008 financial crash. As one of the first few names that come to mind in its category, it is clear American Express is a reliable and stable company that should not be shunned solely based on its dividend growth streak.
The latest dividend increase and share repurchase program are positive developments for investors. The share buyback program alone could potentially retire 16% of the outstanding shares, significantly benefiting shareholders. Additionally, the dividend yield, currently at 1.26%, is competitive, and the company's payout ratio of 0.21 suggests there is room to increase dividends further.
Overall, American Express' recent moves should comfort investors and reflect its confidence in its financial position and commitment to returning value to shareholders. While the dividend growth streak may be short, the company's track record of paying dividends for over three decades and maintaining them through difficult times should inspire confidence in its long-term prospects.
Risks to the bullish thesis
Like any company, American Express faces various risks that can affect its bottom line and market share.
One risk is the current economic conditions, which can exert downward pressure on the company's margins and ability to compete. Higher interest rates and rampant inflation threaten American Express' spending model and could decrease market share. To address this, the company has introduced more affordable options.
Another risk is increased competition in the payments industry. While the industry is highly consolidated, more capitalized rivals and non-credit card companies like Block (SQ, Financial) and crypto companies have begun to compete in the payment processing market. This may lead to greater capital expenditures for American Express, potentially at a cost to shareholders and margins.
Additionally, the company's premium brand could backfire. Although American Express has expanded its non-premium offerings, it retains a premium emphasized through its greater discount revenue from merchants. This, combined with a closed-loop system, may restrict the number of retailers and perpetuate a downward flywheel, which has been a constant risk for the company for decades.
Investors in American Express should remember that, unlike card networks that do not issue their cards, the company retains exposure to potential defaults from its cardholders. For example, during the financial crisis, default rates skyrocketed, leaving American Express vulnerable to losses that non-issuing card networks did not have to address.
In the past, American Express has had a competitive advantage due to its ability to charge merchants higher fees than its rivals. This is due to the contracts merchants signed, preventing them from recommending lower-cost alternatives to their customers. However, this practice has been scrutinized and litigation has been underway for several years. The federal and various state governments have alleged that such provisions limiting merchants from recommending other cards violate antitrust laws.
Although American Express' upper-end clientele somewhat lessens credit risk, the company's customers also have higher demands and even wealthy individuals can face serious credit trouble. Additionally, the company has aggressively sought new customers, which could lead to bringing on less-creditworthy cardholders if underwriting diligence is lacking, potentially boosting default rates in the future.
Takeaway
In summary, American Express shows promise as a short- and long-term investment. Its relative undervaluation, business resilience and revenue flexibility support the potential for greater price appreciation in the short term.
Meanwhile, the company's reputation, brand premium, increased accessibility and ability to lock in consumer spending despite macroeconomic conditions make it stand out from competitors and signal long-term bullishness.
As such, American Express appears to be a strong contender for investors seeking both value and growth opportunities.
