More and more investors and business leaders now believe we are onto a normal V-shape recovery. The supporting evidence from GDP growth and leading economic indicators to corporate and consumer spending are just too strong to ignore. Yet this vision of a normal recovery clashes with other pieces of hard evidence of sluggish job creation, persistent high unemployment, sluggish construction spending and slow lending to consumers and small businesses.
So where does the apparent V-recovery come from? Is it for real and sustainable?
Many economists and analysts have tried to answer these question by examining aggregate reports and statistics such as GDP, Employment, Housing Starts, Existing and New Home Sales etc. While these analyses are useful, many important forces can get lost in the statistics and aggregation. Skeptics and conspiracy theorists will continue to find holes in any of these numbers and trends. Discussions can easily become sports fans' wars of taking sides, or economists' religious fights, both are largely a matter of which college they've gone to.
I'd like to do this differently. Much like what Warren Buffett has been doing by looking into Berkshire Hathaway's (NYSE:BRK.A) component businesses that are vital to the economy: Railroad, Banks, Home Construction and Mortgage, etc.
Let's examine one of Mr. Buffett's long-time holdings, American Express, in trying to answer some of the questions posed above. American Express (NYSE:AXP) is nearly perfect for this purpose, as it is a global business focusing on credit-based transactions and credit lending. We all know that the "Great Recession" we are now recovering from was in large part caused by a credit crisis. Whether or not we're indeed experiencing a V-recovery must be reflected in its various business segments.
Last Thursday, AmEx reported first quarter net income of $885M, double the $437M it earned a year ago during the depth of the recession. Consolidated revenue increased 11% from $5.9B to $6.6B. Both exceeded analysts' expectations. Provisions for losses totaled $943M, down nearly 50% compared to $1.8 billion in the year-ago period. The decline reflected continued improvement in credit quality on the overall portfolio.
It is a very strong rebound. Almost V-shaped, as we will see below in more details.
AmEx has two broad segments: payment business (called "Billed Business" by the company) and lending business ("Cardmember Loans"). So it is very transaction- or spending-based, with about a quarter of sales coming from its leading business. Both businesses are international. They are very sensitive to the speed of economic activities and credit quality.
Chart 1 below from AmEx shows customer spending in a dollar amount and in year-over-year (YoY) growth rates in both "as reported" and "FX adjusted" bases, month by month. Click to enlarge.
For the first quarter of 2010, customers increased spending by 16% from a year earlier. And the YoY growth rate has reached 20% for March. During the first quarter of 2009, the business had a most steep decline YoY in February when the growth rate was negative 20%. The recovery in growth rate is remarkably V-shaped.
In fact, according to the CFO, March 2010 has been the highest March ever for the billed business. During the conference call, when asked how can that be when more people are unemployed and companies seem to be spending less, the CFO said (my emphasis):
I think what we see here is when things improve that discretionary spending is coming back. I think it is really the impact of a more affluent customer base. I think that is one part of it. The next part has to do with corporate card. Corporate card generally is more of a V. It goes down sharper than the rest of spending and it comes back a lot steeper and I think we are seeing that make a strong contribution here. We have a very strong position in corporate card.
Thirdly we have a strong G&S ["Global Network Services"] business. As you can see from the charts spending on cards issued by our partners that run on our network is performing very well. ..
There are three important insights for the V-recovery. First, more affluent consumers have generally recovered, perhaps due to both of their more stable income and wealth recovery. We see more and more retailers catering to affluent customers reporting knock-out earnings and revenue growth. And, they are big spenders.
Second, corporations have come out of the recession in healthier shape than consumers. It is really interesting to see the V-shape mark on corporate spending. Executives need to travel more as soon as business starts to pick up and corporate accounts are not as pinched as consumer accounts.
Third, both exports and imports have been surging. Trade with emerging markets has been a growth contributor, which has bounced back a lot faster than consumer-focused businesses.
We should also note that the current recovery has also been led by manufacturing and technology and most of the activities going there are tied to business-to-business and trade.
Chart 2 takes a further look at the growth rate of the billed business by its following segments: U.S. Card Services (USCS), International Card Services (ICS), Global Commercial Services (GCS) and Global Network Services (GNS). The first quarter revenue of these segments are, respectively, $3.5B, $1.1B, $1.0B and $997M. Click to enlarge.
The most V-shaped recovery is the GCS segment, "reflecting increased spending by corporate cardmembers and higher travel commissions and fees."
The GNS segment has been the most remarkable. It never stopped growing, although its growth rate was tempered by the great recession. The first quarter result reflects "higher merchant-related revenues from the rise in global card billed business, as well as an increase in revenues from Global Network Services’ bank partners."
Of course, not all of AmEx's business recovery is V-shaped. Its card member loan business has continued to decline. Chart 3 shows the growth rate comparison between this business and the billed business discussed above. Click to enlarge.
During the height of the housing boom, AmEx made a strategic mistake to expand its lending portfolio, thereby increasing its credit exposure to consumers who were already very stretched.
The credit crisis has put a huge dent in AmEx's financial performance. But over the course of 2009, the company has sought to shrink the credit exposure by lending less and by controlling credit risk. Recovery for loan growth, however, is nowhere in sight. This also reflects consumers' de-leveraging behavior coming out of the crisis. The declining loan growth is consistent with the "soft demand" claimed to experienced by U.S. commercial banks.
We are witnessing bifurcated recoveries: There is a strong V-recovery, at the same time there is also a very sluggish L-recovery, with the former more tied to corporate spending and international trade and finance, and the latter more tied to domestic and less-affluent consumers. Depending on where you look, you see a totally different recovery.
For the economy as whole, recovery will take the shape of where the leading/expanding sectors are pointing to: a "normal" V-recovery.
Disclosure: Long AXP