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American Express Up, Profits Down

Posted on: October 23, 2008 - Email Article - Printable Version

Chris Barrella

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American Express [AXP: 19.95, 0.00 (0.00%)] blew past analysts expectations after the close yesterday. With consensus estimates calling for $0.59 cents per share, Amex reported diluted earnings per share from continuing operations of $0.74 cents per share, which was down 21% from $0.94 cents a year ago. Net income also came in with heavy losses at $861 million, a 23% fall from $1.1 billion last year. With the earnings beat, shares climbed higher by 8% after hours at one point, adding to the 4% gain during the trading session. Chairman and Chief Executive Officer Kenneth I. Chenault reminded investors of the dangers this market poses stating, “We saw clear signs earlier this year of a weakening environment and the recent volatility in the financial markets has reinforced our view that consumer and business sentiment is likely to deteriorate further, translating into weaker economies around the globe well into 2009.”

Not a surprise to anyone, the continued deepening of the credit markets is beginning to take its toll on the card services sector. This led Amex to increase its consolidated loss provisions to $1.4 billion, up 51% percent from $905 million a year ago, which was mainly due to increased write-off and past due rates on cardholders. Over the last quarter, worldwide card-member spending increased 5%, but that included a 1% decline for U.S. consumers. International card-members helped ease the losses from U.S. consumers with an 8% increase in spending.

Housing Prices Hurting

Amex has historically been a credit card provider for the more affluent consumer and that has helped them weather economic slowdowns fairly well in the past. But, with home price declines of greater than 30% in some of their top spending areas (California, Florida, Arizona) credit deterioration has been widespread and hurt Amex in their core business. Amex has been starting to tally more loses because they are more heavily exposed to the decline in home prices. Amex has 5-11% greater exposure to the California and Florida markets. In theses markets, delinquency rates are 3 times greater than the national average. It is interesting to note that Amex’s higher-end customers are suffering 1.3 times greater losses compared to the subprime borrowers due to such large decreases in homes prices.

Write-offs Rising

Even with average charge-offs rising to 5.9% in from July to August, Amex has been able to stay just below the average at 5.6% for August. As for delinquency rates, Amex was well below its competitors such as Bank of America [BAC: 13.98, 0.00 (0.00%)], Capital One [COF: 33.04, 0.00 (0.00%)], and Citigroup [C: 7.08, 0.00 (0.00%)], at only 3.7% in August compared to an industry average of 4.6%. Even with their rates coming in below the averages, the year-over-year changes in these rates are enormously greater than its peers. With delinquency rates up 45% since 2007, charge-offs have been up an astounding 97% in that same period. This compares to industry average increases of 17% and 55% respectively. It is encouraging to see Amex showing below average rates thus far, but with home prices continuing to fall and discretionary spending in free fall mode, I would expect these rates to go up across the board. Because of this Amex will likely suffer more going forward.

Credit Downgrade

Another point of concern is with Moody’s cutting American Express’s credit rating to A2. With Amex having already raised $27 billion in cash this year and a need for $24 billion more for next year coming from the new Commercial Paper Funding Facility and more long-term debt, Moody’s has also stated that an additional downgrade in the next year and a half is very possible.

Positive Words from the CEO

Even with all the negatives surrounding the earnings report, Mr.Chenault feels optimistic about his company’s position in this market stating, “Our business model is well positioned to generate earnings and excess capital even in an economic environment that is likely to be among the weakest in many years. We believe we have the capital strength, funding resources and comprehensive liquidity plans to manage successfully through difficult market conditions. We remain confident in our ability to emerge from the downturn in a stronger competitive position and continue to see growth opportunities in the payments sector. For now, though, we plan to be very selective with our investment dollars, balancing near term performance with longer term profitability.”

Outlook

Unfortunately, I do not see things getting better for American Express in the near future. With credit loss provisions on the rise, and a strong need for capital on the horizon, I would not recommend getting into any credit service provider. With how Bank of America sunk after their two-week early earnings call, and big credit players like MasterCard [MA: 153.26, 0.00 (0.00%)] reporting in a couple weeks, we should expect more credit downgrades, increasing loss provisions, and a stronger declines in consumer spending across the globe. Prepare for a rocky ride this earnings season.

- Chris Barrella

Disclosure: None

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