American Express reports modest sales growth as global spending trends remain healthy.
The overall premium valuation is challenging, in my eyes, amidst the reported growth rates and the favorable point in the economic cycle.
Combined with downside risks related to the account balances if the economy slows, I remain cautious.
Investors in American Express (NYSE:AXP) were not too impressed with the company's second-quarter results. Despite a very modest correction, shares remain within 5% of their all-time highs.
Given the not-so-impressive topline sales growth, the favorable moment in the business cycle, the more-than-fair valuation, and lack of further drivers going forwards, I remain cautious and stay on the sidelines.
American Express reported second-quarter sales of $8.66 billion, a 5.0% improvement compared to last year.
The payment company posted an 8.8% increase in net earnings to $1.53 billion. As the company has repurchased about one in twenty five shares outstanding over the past year, earnings per share grew much quicker.
Reported earnings were up by 12.6% to $1.43 per diluted share. Including the "net benefit" of $0.05 per share related to the spin-off of the business travelers unit, earnings came in at $1.38 per share, which was exactly in line with consensus estimates.
Looking Into The Segmental Performance
American Express operates four main segments, with of course, the domestic cards business being the most profitable.
Revenues of the domestic cards business were up by 6% to $4.5 billion, thanks to strong card spending and higher net interest income. Higher reward costs and initiatives to drive further growth pushed costs up by 8%, which thereby limited earnings growth to 4%, with earnings coming in at $770 million.
International sales rose by 7% to $1.3 billion, also thanks to strong spending trends. Yet, total costs of the business were up by 18% to $1.2 billion on growth initiatives and restructuring charges of $90 million on an after-tax basis. Even after backing out these one-time charges, earnings would have been down, with net earnings now falling from $208 million to just $77 million.
Sales from the global commercial service unit were up by a modest 3%, increasing to $1.3 billion. The company reported a $626 million profit, or $409 million gain after tax, related to the announced joint venture of its business travel operations. Given the lack of detailed information about the allocation of restructuring efforts, it is hard to say what the profitability of the business would be, adjusting for these items.
Global network & merchant service revenues rose by some 5% to $1.5 billion, again driven by higher card member spending. Higher investments pushed up costs here as well, explaining the 9% drop in earnings to $373 million.
An Update On The Impact Of The Joint Venture
Back in June, American Express announced the sale of a 50% stake in its business travel solutions, in a $900 million deal. The joint venture includes an investor group including funds related to BlackRock and Macquarie, among others.
As should be clear by now, most of the $626 million transaction gain related to the business travel joint venture was either spent or reinvested in the business during the quarter.
For starters, there have been $79 million in transaction-related costs related to this deal. The company furthermore incurred $133 million in restructuring charges, while making a $40 million contribution to its foundation. By far, the most amount was invested in incremental growth initiatives, with the deal adding only $0.05 per share to second-quarter earnings after weighing all these initiatives against each other.
What About The Valuation
On a trailing basis, American Express has now pasted sales of nearly $34 billion, on which it net earned little over $5.5 billion.
With roughly 1.06 billion shares outstanding and shares trading at $91 per share, equity in the company is priced at little over $96 billion. This values the business at 2.8 times sales and 17-18 times annual earnings.
History Of Growth
Between 2004 and the current moment, American Express has steadily grown its sales by a cumulative 60% to $34 billion. Note that sales of the business are tied to general economic circumstances even more than one might expect. This became evident after the company posted a nearly 14% drop in revenues for the year of 2009, for instance.
The company remains very profitable, posting impressive earnings of $5.5 billion on a trailing basis at the moment. Earnings per share growth over this time period was more impressive given the cumulative share repurchases of 15%-20% in total.
Shares of American Express have seen very strong momentum in recent years, trading at $90 at the moment, up from just $10 amidst the financial crisis. At the time, the company turned itself into a bank holding company to make it eligible for help under the TARP program. The economic recovery has sent shares to fresh all-time highs, far above the high of around $60 before the recession hit the company's shares.
Unlike competitors Visa (NYSE:V) and MasterCard (NYSE:MA), American Express is actually on the hook for some of payments being made on its cards, while the two other competitors shift the default risks to the related banks. This means that the company has more upside at this point in the cycle amidst historically low default rates and higher spending.
As such, the company benefited from a 9% jump in card member spending to $258 billion and a 5% increase in member loan balances to $66 billion. Of course, this works both ways and creates some risks to the downside if the economy takes a turn for the worse. In essence, American Express is a mixture of a card company and a bank. This should result in both higher risks and rewards than a pure card company, but less than a pure bank.
At this very favorable moment in the business cycle, I am cautious given the premium valuation versus the market, the already strong operating conditions and the downside risks in case of an unexpected downturn of the economy. Given the lack of further drivers, amidst low loan defaults, just 5% topline sales growth, the more-than-fair valuation and downside exposure, it is rather easy for me to forego making an investment in the company.
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