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American Express's Counter-Cyclical Balance Sheet Is Underappreciated

May 06, 2020 2:00 AM ETAmerican Express Company (AXP)4 Comments
Matt Franz profile picture
Matt Franz


  • Write-offs will increase, but on a lower base on loans and receivables.
  • Lower loans and receivables release capital, allowing American Express to survive a worst-case scenario with adequate capital.
  • The company currently trades for about 9x my estimate of normalized pre-tax earnings.

American Express (NYSE:AXP) was founded 170 years ago and still pervades our daily lives. That puts it in uncommon company. Its premium clientele, low credit costs, and high discount rates are well-known and properly appreciated by investors. But one attribute is underappreciated: American Express's balance sheet is counter-cyclical. Although the company's net write-off rate will rise this year, write-offs will be on lower loans and receivables. As loans and receivables decrease, American Express generates capital, fortifying its position.

Cyclical companies are best valued on their through-cycle earnings. In this article, I lay out three simple ways to estimate American Express's normalized, through-cycle earnings power. I explore the implications of the company's counter-cyclical balance sheet, and finally, discuss whether American Express can withstand a worst-case scenario.

My conclusion is that American Express can, and will, survive this storm and is trading at approximately 9x pre-tax earnings or 11.5x after-tax. The business looks poised to return 11% annually over the long term. The stock could outperform the business by 4% annually if it re-rates to 14x, its long-term median, over 5 years. This means it could double by 2025.

Cyclical But Consistent

Although American Express is cyclical, it worth pointing out that it rarely loses money. Profits oscillate between merely good and excellent.

Since 2005, when American Express spun off Ameriprise Financial, it has averaged a 27% ROE. That's an incredible result considering the period spanned the worst financial crisis in a generation. The company's lowest ROE was 15% in 2009. There are not too many businesses in the world whose "worst" year is a 15% return.

(Source: Author, Data from annual reports)

Berkshire Hathaway's 1987 annual report cites a Fortune study which shows just how remarkable this record is. The study examined the 1,000 largest American companies between 1977 and 1986. It

This article was written by

Matt Franz profile picture
Matt Franz is a Principal at Eagle Point Capital LLC. Eagle Point Capital's objective is to avoid the permanent loss of capital while maximizing the increase in long-term, after-tax purchasing power of funds. Put another way, Eagle Point Capital aims to build an indestructible long-term compounding machine.Matt Franz also writes on Eagle Point Capital's website, www.eaglepointcap.com.

Analyst’s Disclosure: I am/we are long AXP. 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.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (4)

Librarian Capital profile picture
I like the approach of trying to estimate AXP's normalised earnings. However:

Of the 3 methods used, the first two start with a similar loans & receivables number as AXP has today. This seems to assume the non-interest part of the P&L stays the same - which implicitly assumes the 30% of the billed business that is T&E just goes back to normal. It also ignores the hit to AXP's capital base that the article went on to discuss in method 3.

Method 3 starts with an estimates of AXP's post-downturn capital base, which the article believes will first suffer a $4.6bn in the worst case. (I don't think this is the worst case.) $4.6bn is a large number compared to the latest CET1 capital figure of $17.3bn. The article may be right that credit card loans being paid off would automatically raise the CET1 ratio and remove the need of new fundraising - but AXP will need to raise capital if they want their loan balance and thus earnings to return to their former shape (as methods 1, 2 imply).

The actual calculations in method 3 basically assume $21bn of equity (the same as current) and a 25% ROE. The $21bn assumes no hit to AXP's capital base, which I think is doubtful; the 25% ROE figure, while it seems superficially conservative compared to the 2019 figure of 30%, ignores how AXP's ROE has been trending down fast (it was 33.5% for 2018) due to its capital-intensive growth with loans. (The worst case also starts with a $21bn equity, ignoring the $4.6bn loss the article itself discussed, so it doesn't seem really the worst case.)

The big question for AXP is when things normalise - billed business was actually down 45% year-on-year in April, because in addition to T&E down 95% non-T&E was down significantly too. And, with 30% of billed business from T&E (including 7% from airlines), and the business model being quite leveraged, there is a good chance that even a 15% ROE may prove too optimistic, let alone a 25% one.
Matt Franz profile picture
Thanks for your detailed comment. You're right - there are two variables here. Credit costs are rising while loans are falling. If you look out 5-10 years, I don't think you need to worry too much about what the exact mix will be next year. There is a wide distribution of outcomes for next year, which if why I took a stab at a worst case scenario. I think my worst case scenario is reasonable in that RWA will probably contract faster than I assumed, which leaves room for greater credit costs than assumed.

My expectation is for a U shaped recovery. If billed business recovers in two years, as it did in '09 and '15 then the stock should do well. If we're in the early days of a depression, it won't.

In a U shaped recovery AXP will need to retain capital to fund new loans. Buybacks will most likely remain on hold. If this happens, discount revenue will return and generate a lot of capital. They might need 1-2 years to rebuild capital.

Overall, I think the distribution of short-terms is too wide to handicap. If you think AXP can survive long enough to get to the long-term, then their long-term earnings power is substantial. The risk seems to be dead money for a few years while they rebuild.
Alfonso Benz profile picture
Great article. I would like to add that American Express achieves a 10% yield on its loans. So, if it reached a delinquency of 8% as in 2008, it would still be less than the earnings from the loans. the data is $ 80kM in loans and $ 8kM in gross interest earnings. Regarding the evaluation, if we look at the operating cash flow the company is trading at only x5. I recently bought. I share a post on the subject.
right mindset bro i bought in the high 60s but it is now to cheap too
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