Credit Card Breakdown: AmEx Disappoints, as Predicted

I’ve been saying the same thing for months. Ignore American Express (AXP) because of its exposure to consumer debt. But no one listened. AXP will be fine, they said. You’re blowing the consumer issue out of proportion. “Ian Cooper has no brain,” said one reader.

But we were right.

Last night, American Express posted a Q2 profit that fell 38%, well below Street forecasts, as consumer spending slowed and the number of loans that were written off increased beyond expectations.

For Q2, the company posted net income of $653 million, or 56 cents a share, as compared to the $1.06 billion, or 88 cents per share posted last year. Analysts expected 83 cents this time around. Net loan write offs came in at 5.3%, as compared to 2.9% year over year.

And it only confirms what we’ve said all along. Here’s what we reported in Wealth Daily on July 5.

“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 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, whose 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 wacked 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.”

So where are the best opportunities to make money?

If you must own a credit card stock, buy Visa or MasterCard. They do not have exposure to consumer debt. As home equity dries up, more people are turning to plastic to pay bills, buy groceries, etc. Visa and MasterCard are card processors.

Once a MasterCard or Visa card is swiped, these two companies make money. Buy Visa on weakness and hold. Visa reports earnings on July 30. MasterCard reports on July 31.

Disclosure: None

Comments

[traderv]

Nice call, Ian

[icandoitdon]

sounds like another "buy high sell low" strategy to me. you cannot talk about increasing credit risk without talking about the correllary decline in credit and credit activity, hence transaction volume.

MA has doubled in the last year and gone up over 5 fold in two and currently sells for 30 times 08 estimates. visa is at 35X. if either miss estimates or reduce guidance because of a weakening economy, their stocks will hurt you. even without miss or reduced guidance, where is the upside with a weak macroeconomic outlook and trailing p/e's pushig 30?


with a lot of bad news priced in, AXP will tread water at best and possibly drift to the high 20s/low 30s so i would wait for lower prices before committing. but it doesn't have the potential to hurt you without significant further deterioration in credit conditions; and the upside, with an eventual turn in the credit markets/economy, is a hell of a lotmore attractivethan for either MA or visa.

the idea is to buy low sell high...not to buy high and tread water.

[icandoitdon]

p.s. it was a nice call on amex though

[Hanoch]

I couldn't disagree more. American Express is one of the best managed companies in the world, with a franchise that is virtually impossible to replicate. Its growth prospects are tremendous as nations like China, Russia and India continue to develop, and demand for Amex's products continue to spread and grow globally.

Yes, from time to time, the economy turns downward and that affects Amex's (and virtually every other company's) bottom line. It is hard to imagine that anyone was seriously surprised by Amex's results. But for an investor, rather than a short term trader, current economic conditions are not the deciding factor in valuation. That comes from a long-term perspective. The fact is, over the last ten years, Amex has nearly doubled its earnings, significantly increased its return on equity, and reduced its share base.

I have little doubt that, in a year or two, people will look back at 2008 and kick themselves for not picking up shares of one of the world's premier companies at a bargain price.

[VCASHCOW]

Hanoch - AXP maybe a well managed company, however, they're business model is extremely susceptible and overexposed when the American economy turns downward. It's clear from your blog that you're upset by not knowing when to pull the trigger and realize gains.

By reviewing AXP's stock chart it's all but written in stone when you should have sold/pulled the trigger. If you do not like losing money you should buy (V), (MA), or (CAT).

[bishk1301]

They are making a lot of money from merchant fees. They are serving affluent consumers. They are charging killer rates. The use of plastic is going to grow compared to cash. This company is being valued as if it were a business which is going to disappear. If the defaults continue rising they will raise rates and fees. V and MA are in a better condition now but they are fully priced and might come under additional pressure for monopolistic practices. Defaulting on credit card is harder than walking away from the home with negative equity, cause you have to continue to buy everyday's stuff. Doomsday sayers will know the wrath of rising markets one day. Excellent companies like AXP will blow short sellers away

[Hanoch]

VCASHCOW--No remorse here. In my view, even assuming a pretty horrible year, AXP is worth at least 50 (likely more), and I have been using this opportunity to add more. Thanks for the advice though. Time will prove one of us wrong.

[greencapitalist]

adding axp? my friend be slow to add though.

you might want to buy ma. grossly undervalued at 2009 valuation trading lower than its projected 2009 growth.

matrader.blogspot.com

[Kunst]

American Express is more expensive than Visa and Mastercard on both the consumer and merchant side. We have dumped them on both. I just don't see what makes them special enough to command a premium.

[Bright]

Very insightful and I agree. Although we do not hold a crystal ball. "Do you?" Let me know.

[Frank Rong]

I still think Ian cooper is an idiot. Some consumers are cash strapped, most of American are doing just fine. Amex's problem is really Amex's problem. The numbers of people who defaulted on loans at Amex felt to 5 years low, (Amex Master Trust), but the loan balance per default account doubled from three years ago. One possible reason? It juiced up spending volume by giving people too high of credit limits. I don't like Amex for now.

MasterCard and Visa are equally toxic. What's stopping a large card issuers from switching its card to Visa from MasterCard, or vice versa? Prices. Visa, MasterCard and Discover will be in a pricing war to get cardissuers to issue their card.

I like Discover, its earning is still strong. Although charge-offs are picking up recently, that's not a big deal, these losses can be offset by hiking overall rates on customers, or hiking fees on Merchants, and lower funding costs due the lower interest rate cut by the FED

Visa and MasterCard's loyalty lies with large banks. Top 10 banks control almost 70% of the transaction volumes, losing one large client will see the stock price fall off a cliff. That will happen after banks sell their stocks in MasterCard and Visa.

Visa and MasterCard are like emperors without clothes, they don't have any direct relationship with consumers. Their futures are in the hands of large banks.

I wouldn't touch V and MA with a 10 foot pole, these two stocks are the trainwreck waiting to happen, after about 1-2 years from now. People who buy these two stocks don't understand Microeconomics

[mojo7489dumpass]

mojo7489, you are really a dump ass

[Adesai]

Mojo is an idiot, its clear he loss some $$$ in Amex and DFS.

Have you seen MA chart for the last 2-3 years. Its on a steep incline.... WHY???? MA and V is targeting developing countries. In china 1 in 30 owns a cc; in india its about 1 in 60. These are huge potential markets. Global trend from cash to credit is occuring at a exponential rate. With the summer olympics along with huge chinese/ indian/ middle eastern banks investment in V, look for about 10-15% increase in credit card transaction year on year, which is what CEO saunders has predicted. Suntrust has a price target of $100 which is what V willl likely be trading at within several months.

Amx and DFS will likely be bankrupt or be in the red within several years.

[Cat~eyes]

Adesai: Good to see you.. you're right on with the data regarding the rapid global growth that both V and MA are experiencing.

I know 90% of the people here understand this but let me re-state it.

1. Visa and MasterCard are in the Services sector. American Express is in the Financial sector. Apples and Oranges.

2. Visa and MA will NEVER turn into a credit issuer as a previous poster suggested, they will never be worried about whether someone defaults on their credit or pays on time.

3. As a poster here pointed out, Amex is experiencing huge amounts of large credit line defaults - again, an issue V or MA will never have to deal with.

4. "Although charge-offs are picking up recently, that's not a big deal, these losses can be offset by hiking overall rates on customers, or hiking fees on Merchants" - mojo

- Yeah... and the consumers are just going to rush right out and apply for Amex because they want to pay the extraordinary fees that won't amount to a drop in the bucket in terms of making up for the huge charge-offs and credit defaults Amex is dealing with now.

5. I'm pretty sure I won't look back in 2 years and wish I'd bought a few shares of Amex today.
Even though I think financials will eventually come up for air. There are just some credit issuers, lenders, and banks that won't survive long enough to catch that life-saving breath.

[mrbill for V]

Hanoch, good points, very level headed comments, i have to laugh when
i hear comments like AMX won't be around in two years. All stocks including V and MA will experience all time lows and highs.

[Cat~eyes]

I think Amex will be around in 2 years..of course, I just don't think some of the banks will be.

And yes... ALL stocks now matter what sector, will have highs and lows..it's one big roller-coaster ride.

[VCASHCOW]

mojo7489 - Visa and Mastercard will not lose big banks as customers as they have no alternatives to electronic payment processing. The banks created these giants and receive fees from the merchants when Visa and Mastercard are swiped, furthermore the governement will not allow a bank like Wachovia or Bank of America to fail.

Bank of America would love to create their own brand of card, however, they currently do not have the capital to develop their own payment platform.

The barriers to entering this business are hugh and the banks shot themselves in the foot by allowing this oligopoly to go on for so long.

You should already know that the banks sold the majority of their Visa Shares after the IPO. Why do yout think their recovery was so overstated in 04/2008 (They made millions from the IPO).

V & MA are great stocks but there are clearly risks involved. At this juncture the risks are outweighed by the great potential in emerging markets as stated above by Adesai. The growth in emerging markets will offset any roadblock in the U.S. over the next 3-4 years. Adesai hit it on the nose man.

mojo - I know you like AXP as they have a great track record, but AXP is not in favor and their business model of handing out free money in the hopes that consumers will repay is bound to burst.

[VCASHCOW]

mojo - You should buy (JBHT) when it becomes oversold. Now thats a monster of a performer.

[Cat~eyes]

VCashCow: Great analysis of the information...

[VCASHCOW]

I've provided the link below to ease the mind of anyone worried about pending and future litigation against VISA. The link provides a photo of $206,000,000.00 seized from a cartel by Mexican and DEA agents. Multiply the photo by 14.492 and you'll have the sum of VISA's initial litigation escrow account deposit. This account serves as quite a hedge. usdoj.gov/dea/pubs/pre...

[VCASHCOW]

usdoj.gov/dea/pubs/pre...

[VCASHCOW]

***This is the correct link ***
usdoj.gov/dea/pubs/pre...

[Prognostic]

I am not worried about MA beating the results handily.

I am worried about what they will say on a going-forward basis. Just a couple of months back MA management came out and took the highest analysts eps number and called it low and increased guidance! The stock shot to 300+ and the shorties came out driving it to current levels. The shorties don't believe that MA growth can be sustained and that the macroeconomic environment will eventually start affecting them.

As pointed out in above posts there is a fundamental lack of understanding of the dynamism of developing countries where the populations largely operate using cash and the massive switch that is happening to MA and Visa issued plastic. So even with a cloudy macroeconomic situation one would argue that more and more cards are being issues in these developing countries and more and more transactions are moving to plastic from cash.

Comments welcome!

[BullishBankers]

There is a great article about Visa and Mastercard here: www.bullishbankers.com.../

[User 172125]

I appreciate all of the post and the comments and the bullish bankers article was on the money. Also, good to see you Cat, Green Cap, and Aesai. What a surprise- Mr. Bill actually has an opinion on something!!!

Yes Axp ind DFS are different animals. Unfortunate for the masses this is not as well known as it should be. Earnings this Wed (V) and Th (MA) will further delineate the differences.

We will soon be advertising on Seeking Alpha for our family of blogs and new site/forum. In the meantime - one of our blogs is devoted to V:

www.visawinners.com