Why American Express Should Be Ignored

American Express (AXP) continues to be a favored short. And that's because they hold consumer debt, and fall prey to mounting delinquencies. So when I learned that UBS upgraded the stock last Tuesday morning from Sell to Neutral, I had to laugh at the absurdity.

The argument remains the same, though.

If you want to own a credit card stock, buy Visa (V) or MasterCard (MA). They do not hold consumer debt. They simply process the cards.

American Express, on the other hand, deals directly with credit. It has to worry that as of November 2007, credit card debt "soared at an 11.3 percent annual rate in November following an 8.5 percent rate of increase in October" and is still on the rise."

They're the ones where share values are being beaten stilly because of charge-offs, payment delays, and higher delinquencies. Why do you think Discover Financial Services' (DFS) stock plunged from a $35 IPO price to $13? It's a card lender, and concerns itself directly with cardholder debt.

Same goes for American Express, who's CEO said:

Business conditions continue to weaken in the U.S. and so far this month [June 2008] we have seen credit indicators deteriorate beyond our expectations.

It was January when AXP's CFO Daniel Henry predicted that the company's U.S. write off rate would peak between 5.1% and 5.3% in 2008. Unfortunately, a 5.3% write off rate was reached in March. It's now July and delinquencies and default rates are growing worse.

The United States of Cash-Strapped America

With homeowners struggling to stay above water, American Express has to worry about further delinquency problems, as credit card debt balloons. You're better off longing MasterCard stock and Visa, than naively risking bets on American Express stock.

Instead of just using credit cards for big ticket items (TVs, furniture), some are now charging gas, food, and even paying other bills with them. And some are only making minimum payments... if they can afford even that.

It's far more difficult these days for many consumers to dig their way out of debt, since other relied upon options, such as home equity lines of credit, are no longer readily available.

National revolving debt just hit a record $957 billion in April, from $800 billion four years ago. Total credit card debt was up by 0.4% in April, according to the Fed. And Moody's is reporting that the charge-off rate, which measures credit accounts considered uncollectible, hit 6.27% in April.

Q1 consumer borrowing skyrocketed to $34 billion, the biggest amount since 2001 when the U.S. was diving into a recession. And not all of that may be paid back. Credit card investors are becoming increasingly concerned that a weaker U.S. economy will hurt borrowers' ability to pay back debt.

But as long as there are naïve investors, and foolish upgrading banks, it's hard to get that reality to the investing masses. Still, downside risks remain at American Express... even Discover and Capital One. They'll slide long-term as subprime fiascos are replaced with Option ARM reset fiascos.

High Gas Prices, Housing Slump, and Rising Unemployment...Oh My

Credit card issuers will face more losses than initially expected.

Hit by cash-strapped consumer reliance on plastic amid rising gas prices, a housing slump, and rising employment, credit issuers could see earnings thwacked by defaults.

"The deterioration in credit cards is accelerating faster than many had expected," said Christopher Wolfe, an analyst at Fitch, according to CNN Money. "The message we are trying to deliver is that things are going to get worse before they get better. Thus far, credit card businesses have been profitable but that could change."

Worse, according to the CNN Money article, "Fitch analysts are expecting an increase in prime charge-off rates - or losses from defaults on card payments as a percentage of loans outstanding - to at least 7% by the end of the year from 6.4% in May."

Vulnerable are credit issuers like American Express, Washington Mutual, Capital One and Discover, not the Visa or MasterCard-like companies.

Ignore or short American Express... and hold long-term. Buy Visa or MasterCard stock if you must own a credit card company.

Disclosure: none

Comments

[fxtrader07]

counterintuitive as it may seem. axp probably is the better deal compared to MA andV here. why? simply because the expectations diverge so massively. on one side, axp, where people fear for something pretty short of armageddon. on the other, v and ma where people - absurdly- think that they were immune from global economic slowdowns and are willing to pay up big time for a perceived growth that may or may not materialize. the former, axp is exposed to positive suprises from here - while the opposite holds true for v and ma.
as for me, i to ignore all three of them at this time

[Jake Blues]

Nope.

V and MA make money by the swipe, and swipes are way up. The number of swipes will continue to climb as the BRIC countries expand their middle class. V is particularly poised for a breakout with the upcoming Olympics. Both of these stocks have been unfairly punished because they are incorrectly being lumped in with Financials.

[mrbill for V]

Good point FXTRADER07 of course all those bloggers who hold V and MA don't want to hear anything but positive news because many of them put their life savings in these stocks. It's so funny to hear stuff like "V is going to put my kids through medical school" on just a 1000 share purchase no less. The fact is both stocks will experience all time highs and lows. Even at $72.00 for V those of us who bought in early still have nice gains. Massive profit taking which is going on now is unavoidable due to market conditions. Can't wait to hear that i am crazy and wrong.

[Adesai]

I enjoyed this article and you made a great point Fxtrader. However with Visa being traded at 72 currently this stock has taken a beating. Suntrust has projected price target of 100, and there is no reason to believe Visa cant hit that with the upcomming olympics, growth potential in asia, buying visa europes, and buy back of shares. Visa is expecting 20% growth year after year.

Remember that before the first quarter earnings Visa was at prices of 73-75, after the earnings release the stock jumped to 80+. With second quarter earnings comming up look for the same trend. Visa and MA are being traded at high PE ratio compared to other credit cards, which is justified b/c of the limited or no exposure to consumer debt. While AXP and Discover will likely fall victim, as have banks recently, to the badd economy. The price of V has taken a beating because of lower expectations from the financial crisis, however once earnings release watch this baby sky rocket.

[fxtrader07]

@jake: they are different than axp. still, expectations of exponential growth more often than not do not materialize. europe is close to a recession now and the u.s. is already in one - except for the number massaging done by the govt. anyone who believes the emerging markets will be immune from that is just dreaming. the high oil price masks the decline in many commodities and by now oil is pure speculation. a year from now it will be back to 80$/bl, asia and brazil will have tanked big and people will wonder how all that 'growth' could disappear so quickly. well, it hasn't . it has never been there in the first place - only in the expectations of people who extrapolate past trends indefinitely into the future

[markb]

I actually like AXP and am looking for an entry point. I think Ian's article is somewhat "naive" in that there is no information an average investor hasn't already considered.

Here are some new tidbits:

1. AXP is mostly a network business like MC and V (eg no lending on most AXP products). They also have some lending, but they are not primarily a lender like a bank card issuer.

2. AXP has been building share in both network and lending by winning in the marketplace. On the lending side, even in a stable economy, you would be seeing AXP default rates go up now as recent balances are seasoned. But that lending would still be profitable on an IRR basis...the default rates are timing related.

3. OK, we don't have a stable economy, but the sky isn't falling either, particularly for AXP's premium customers. But if default rates go up for a few years, so what? Did you forget that AXP won judgements of about $1B each from V and MC? Goes a long way to shoring up an already very strong balance sheet.

4. Regarding valuation and sentiment, I agree with mrbill that V and MC fans, at least here on SA, are like a cult that wants you to drink their kool aid. The V/MC business model doesn't involve debt at a time when debt is out of fashion, fine. But what are they really? Back office processors. And their only real advantage is monopoly status...do people say "I choose Visa over X, Y or Z networks?" Not really. As monopololists they will invite continued governmental scrutiny on interchange, especially overseas and possibly in the US under a more populist democratic regime.

Recall that V/MC do not control their own customers. The banks do. And the supreme court case that led to V/MC giving AXP billions also said banks should feel free to issue cards on the AXP network. AXP interchange rates are much higher than V/MC so banks have an incentive to split profits on their high spending non-revolvers with AXP rather than sending them through V/MC. This is a real business at AXP called GNS and its one of their fastest growing.

So in conclusion, V/MC might do ok over the next 5 years but I'm betting AXP will do better. I don't view that position as naive.

Enjoy the kool-aid.

[Plantinseeds]

Anyone that belives that oil will be $80/bl a year from now just don't get it.
We will never see it go below $100 again IMHO.
Those that own the reserves will not let that happen. Besides they ain't makin no more oil!

Visa is not going to skyrocket after earnings report. It will move up but nothing in this market is going to skyrocket per se.
Long term MA or V is a great investment.
Not even Vwinner can propoganda the stock up in this market.

[IANR]

Ian's (not me) article is very short sighted and too simplistic IMHO. He ignores the fact that AXP is reserving 100% of ALL deliquencies each Quarter. He ignores the fact that AXP have a little over $4 Billion coming in over a 2 year period, from his favorite picks Visa and MasterCard. MORE than enough to top up those reserves and they also sold AEBL to Standard & Chartered 2nd Quarter 2008. Sure delinquencies are rising, but you have too look at how well reserved a company is and how well they can work through the current economic climate and how well positioned they will be for a better economy in 2009 and 2010. Then you have to consider how much the stock price has retreated from October 2007 and consider if this is an over reaction based upon the above. Seems UBS did this thinking and Ian did not....

[User 226632]

I actually agree with most of the comments for/against AXP. We know what IS/CAN go against it and what HAS BEEN/CAN go for it. Isn't that where risk/reward come into picture? :) ..I, for one, think AXP has huge potential. With most of the financial firms littered with liars on top (JPMC chief excluded), this one got a great management (IMHO). To sail through the rough time they are in a very good financial health, it is not very capital intensive. With the rise of (and rising) emerging markets such as China, India there are so many "rich" people coming out now from those countries that see AMEX card as kinda status they gotta have. If anyone needs any proof just visit one of these countries for business purpose and go out for dinner with some of your clients and you will figure it out. A company like AXP, you will never get to be able to buy it in "high" market to see huge gains. Just look at past 10 years events and its effect on AXP and eventual outcome.

Ofcourse there is a risk and there is no stock purchase without any risk :) ..I am putting lot of faith on management and assumption that data provided by AXP is not manipulated - now thats a big trust but I trust AXP management. The day I can see a proof that they have not been honest with their share holders I will walk out of it. Based on this bad data, I just don't think it warrants to trade it a low price it trades currently. For me upshot is huge and if I am wrong (after all there are uncertainties) I will have to bite the bullet.

Now, about MA and V - I like both of them too. I would prefer V or MA.

[greencapitalist]

good call ian.

but remember even with v at 70, ma is dead cheap. so cheap it is trading at par with its growth for trailing and forward valuation. if market gives v, ma's valuation, v should be 60 to 64. this is hard to believe but in this bear market valuation compression will happen as it is happening for ma.

at 80 for v, it is really insane valuation. this means a 20% eps growth company like v, is being valued double that. no wonder it was sold off.

v has breached 70 support is super heavy volume. i wont touch v here. i will wait to see if 68 or 65 support holds.

as always ma is a strong buy here. <<<<matrader.blogspot.com&...;>>>

remember discover beat by 13%. v will smash by 25% and ma by 40%. why ma more beat. simple hyper europe story and strong global play. visa less of a beat because of strong america play where credit card market is to the full level.

[adik]

Forget Amex, don't touch it, they will sell their mother for a dollar, their cards are still accepted in Terrorist Iran while Visa & Mastercard are not. Can Amex be more American as a company yet be so unfaithfull !!!!! where is the Treasury Dept, Justice Dept. etc.
Funny World.

[Cat~eyes]

Can anyone here explain (in layman's terms) how to find the fair value of stocks? I know it's not black and white, but some explanation would be helpful.

On a different note, I know people here think Visa bloggers 'drank the kool aid' but there are a few of us who actually understand that ANY stock is a risk, and there is NO stock that is all good news. You need to know about the good and the bad, equally, to be fully informed. Otherwise, it is a cult.

And for those that bought any stock thinking it would put their kids through school, etc, should prepare the kids for home schooling with the market being what it is now.

[mrbill for V]

Cat~eyes This link should help for fair value

en.wikipedia.org/wiki/...

[Cat~eyes]

Thanks for the link mrbill.. it's been a while since i took stats, but I think I can figure this out based on the formulas given (especially in the average growth approximation).

[Loaner]

I am a contrarian investor, however in this case and for now, I would not touch AMEX. I am long MA as it's business model is as basic as it gets ($$$ per swipe)and easy to understand. It has taken a beating lately because it's mislabeled a "financial" when its a tech stock. Good buy right now in my opinion.

This said, Amex is a great company, and may well be a decent investment at some point, you could do a lot worse.

[kotika98]

I think when the dust settles, we are going to see just how well CC debt holds up during the crisis. People walk off away from their mortgages because thats what they intended to do all along, but nobody can afford to give up their credit card expecially people with financial problems. Having no access to a credit card is worse than having no car in modern day america. In 2008-09, watch people going through extreme hardship and still managing to pay off the credit card...

Just ignore the self-serving short's comments.

[Frank Rong]

Ian Cooper has no brain, Discover and Amex are far better businesses than Visa and MasterCard. DFS and Amex are getting paid for taking the credit risks. Much more pay than the risks they are taking. Delinquency and Charge-offs are irrelevant, since they can passes along higher loan losses to customers thru high interest rates. MasterCard and Visa on the other hand will have to compete against DFS and AMEX for renting out their networks.

[traderv]

User 227306 -- you have no clue what you're talking about.

[traderv]

sorry. that comment was directed at mojo7489.

[VCASHCOW]

I agree with traderv. Mojo7489 has not the foggiest idea of what he's proposing. Good companies unlike DFS don't sell investors worthless paper. (V) & (MA)'s stocks have shot up simply because they make money by selling their brand name and transferring value from a consumer's bank account to the merchant point-of-sale. V & MA have very little debt creating hugh margins which will surely increase. (V) & (MA) make money even in bad times.

(MA) was definitley a better investment then (V) due to less shares outstanding and (MA)'s position to obtain market share overseas, however, (V) is the stronger of the two as (V) already controls the majority of the american market and are now focused on emerging economies. (V)'s value to shareholders will materialize slower than (MA)'s has due to expectation differentials. If (V) went public before (MA) the roles would be reversed, in fact (V) would already have surpassed (MA)'s current price.

(V) appears to be a nice hold for the next 2 - 4 years. The time horizon for cashing in on (V) for the long term investor has been pushed out farther due to economic slowdown. (V) should increase nicely during the next upward cycle.

[VCASHCOW]

All Plastic cards look similar but are very different - Don't get it twisted.

[Cat~eyes]

mojo:
Take a look at the Relative Strength Index (RSI) for Visa (V). Comparing it with the S&P, Dow, MasterCard, Discovery, and American Express, you'll find that Visa OUTPERFORMS all of these over a 6 month and year-to-date time line (caveat: MA has surpassed Visa for the last 2 weeks based on RSI).

While this may not be an indicator of who is the "better business", it clearly shows that V clearly outperformes versus the S&P, Dow, and other Credit Cards... a pattern emerges.

[Cat~eyes]

Meant "Discover", sorry :)

[steve@bullishbankers]

Names like American Express and Discover Financial will be hurt with these delinquencies as they will be forced to write-down their portfolios. The pure-play card servicers aren’t completely recessionary proof, but history has shown that they perform well during these times and extremely well during recovery periods. Visa Inc. and MasterCard Inc. will continue to outperform their peers and are safe plays for any portfolio.

So just how much money do they make on transactions?

As an example, let’s say you go out and purchase a watch for $100 by using your Visa card. Out of that $100 purchase, the merchant would usually pay 2%, or $2, of that fee for the use of the card (fees for merchants vary, as larger corporations like WalMart pay less than the typical Mom & Pop Shop). Out of that $2 fee, only about $0.20 go to Visa the rest would be paid to the issuer of the card (ex: Chase, Citi, etc.) and the bank it corresponded the transaction with. This is a pretty profitable business for all parties, but Visa acts as a pay-as-you-pass-go service because the transaction is made on their network, VisaNet.

Market Share

Visa Currently dominates the market across the board in total volume, transactions, cards, merchant outlets, and ATM’s. On a total volume, transaction, and card base, Visa is bigger than MasterCard, American Express, Discover, and JCB COMBINED! Out of the total credit card volume (excluding Europe) Visa operates with over a 60% share. Visa’s dominating market share isn’t a thing of the past, as transaction volume will continue to grow as they have issued the most cards versus their peers.

Visa vs. MasterCard
The similarities between the two companies are striking, as they both operate as card payment networks and don’t hold any credit exposure on their books. The main differences between Visa and MasterCard are: their IPO dates, litigation issues, geographic revenue streams, size of networks, and efficiency.

bullishbankers.com.../

[V Winner]

Read the bullish bankers post and it is good stuff.

I've been bullish on V from day one and even developed a blog around it:

www.visawinners.com

Come check it out.