3 Challenges Ahead For American Express

| About: American Express (AXP)

Summary

Billed business will remain challenged from increasing competition.

Management's cost improvement may not be as effective as we think it will be.

Loan delinquency could increase in the second half and maybe into 2017.

American Express (NYSE:AXP) reported its second quarter earnings that beat analyst estimate due to positive impact of Costco contribution. Earnings per share was $2.10 but actual earnings came in at $1.54 when we remove gains from the Costco portfolio sale and the restructuring. This quarter was particularly good for American Express because the company enjoyed almost a full quarter of Costco volume before the sale to Citi. As for the guidance, American Express is looking for $5.40 to $5.70 in earnings per share but also cautioned that the second half earnings will be lower than the first half due to higher investment spending.

I would continue to avoid American Express and want to reiterate that Visa (NYSE:V) is my preferred stock in the diversified financials area. The basis of my reasoning is that American Express's revenue outlook remains a concern to me given the increased competition from Visa and MasterCard, as well as indirect threats from PayPal (NASDAQ:PYPL) and the likes of Apple or Android pay. The customer base for American Express is also smaller relatively to the other cards, which means that American Express has to drive higher spend per user to be competitive against Visa that can easily rely on big card issuers such as JP Morgan or Citi to drive growth. American Express management acknowledged that higher marketing by competitors is driving incremental customer losses because the competitors are targeting the same customers that American Express targets. What worries me more is the potential competitors co-brand their cards with more attractive rewards that could potentially cause more American Express customers to switch.

Additional concerns that investors should consider when investing in American Express.

First, bill business will remain challenged in the near-term. Billed business growth slowed to 4% from 6% in the first quarter when we adjust for foreign exchange. Reported billing in the US growth was 2% and 7% excluding Costco. Management acknowledged that a portion of the new cards accounts from the Costco co-brand who signed up for American Express products and they expect to capture 20% of the spending from the former Costco co-brand card members. However, I believe that the competition from Citi and other banks could reduce the billed business growth as competitors introduce more premium card products such as Citi's Prestige, which has done a good job attracting American Express Platinum members.

Second, expense management may be less effective than the market assumes. It seems that American Express expects by increasing expense in the short term and lowering them in the future could result in "cost savings" down the road. Let us face it, this is not called cost saving by any standard. The company did something similar in the past but was less successful in lowering the cost so investors should be skeptical. The company pointed out that the increased spending was necessary to reduce cost in the future but what they might not be considering is that if competitors increase their promotional activities then American Express most likely has to follow suit and this will keep the expense elevated in the second half.

Finally, credit quality could be a concern in 2017 because American Express retained $245m of loans related to the cancelled Costco accounts that increased the delinquency rate by 10bps in the quarter. This could increase American Express's reported loss rate for the second half and into 2017 and this is a particular concern when combined with a modest growth profile given that American Express will be required to have higher reserve build that will likely to pressure earnings in the near-term.

In conclusion, I will avoid American Express in the short-term and instead prefer to buy into Visa.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.