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American Express (AXP)
Some Short-Term Pain Notwithstanding, American Express Should be Fine
American Express is another one of those financials whose stock has been hammered over the last few months. The stock was trading at around $63 this time last year and now it is changing hands in the $39-$40 range. However, yesterday brought some good news for AmEx shareholders. The company settled a four year old lawsuit with MasterCard over the anti-competitive restrictions that were imposed by MC/Visa, in the late nineties and the earlier part of this decade. MasterCard (MA: Charts, News, Offers) and Visa (V: Charts, News, Offers) prevented banks from issuing credit/charge cards under the American Express brand. MasterCard will pay a sizeable $1.8 billion to settle these claims in quarterly installments of $150 million. For American Express, this is in addition to the $2.25 billion it wringed out of Visa last year over similar claims. So why is a company that is on deck to receive close to $900 million each year for the next 3 years due to these settlements, failing to generate any excitement in the stock market?
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First of all, most investors tend to focus more heavily on operating and continuing earnings from the business rather than be swayed by one-time gains such as these. The biggest knock on AmEx right now is the weakness of the consumer. A Conference Board report released a couple of days ago indicated that US consumer confidence is at a 16 year low. High commodity prices, along with falling real-estate values and an uninspiring employment picture is putting the squeeze on Average Joe. And even though the average American Express card member is more affluent than the Average Joe, AmEx is still feeling the pressure of watching its cardholders miss payments and default. Even though AmEx has traditionally gone after only the high-end of the credit card market, it has been relaxing its credit card eligibility restrictions over the past few years to attract greater business. Also, AmEx was known for requiring its members to pay off their balances in full each month. Some flexibility has been introduced in that area too with the company now allowing card members to carry a balance on certain purchases. While these changes work well in good times and allow AmEx to earn a greater amount of interest, in lean times, they heighten risk exposure.
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And that is what CEO Ken Chenault indicated yesterday in a statement which basically amounted to a profit-warning in advance of the company's quarterly report due out next month. He said the credit cycle has worsened beyond the company's expectations. So clearly American Express is having to write-off more loans that its internal models had predicted. In the beginning of the year, CFO Daniel Henry said he saw the write-off rate in the US business rising to a maximum of 5.1 to 5.3% in 2008. Well, it is already at 5.3% and not many people are suggesting that this is the bottom of the consumer confidence cycle.
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Therefore, the pessimism on the street about Amex has basis. It might be a little overstated though. American Express has posted decent earnings over the last two quarters and hasn't reported monster write-downs, like other financials. For Q1 of this year, net income from continuing operations was 84 cents which was down a little bit from last year but it still beat analyst expectations which were at 81 cents a share. The company's management also deserves credit for not getting swept up in the mortgage boom of the past few years and straying from the core business to invest in these areas (think Wachovia (WB: Charts, News, Offers)). MasterCard and Visa, both of which have had high-profile IPOs in recent times seems to have escaped the street's wrath and their stocks are flourishing. Granted there is a key difference between Visa/MC and AmEx which is that the former do not take on credit risk (i.e. make loans) as they are purely in the business of processing transactions. That eliminates exposure to delinquencies but it does not eliminate exposure to a slowdown in credit card spending, one of the reasons that AmEx has been punished. So, over the intermediate and long-term future AmEx seems to be in a good position to reward shareholders, if they can withstand the short-term pain.
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Click here to view a detailed profile of American Express.
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