11/25/13 Covered Call Pick: American Express Company (NYSE:AXP)
American Express Company (AXP) is an American multinational finance services, credit card, and payment products corporation. One of the 30 members of the Dow Jones Industrial Average, the company is best known for its credit card, charge card, and traveler's check businesses that it offers to consumers and businesses worldwide, and its Roman gladiator logo is recognized and respected all over the world.
American Express has a market capitalization of $89.83 billion with $1.07 billion outstanding shares.
American Express currently pays a $0.23 quarterly dividend for a current yield of 1.1%.
With a beta of 1.09, AXP currently trades with approximately 10% more volatility than the current market.
As the year begins to come to a close, we enter the holiday season and consequentially the largest season for retailers. This means a lot of money exchanging hands as consumers pull out their wallets and prepare to spend. While this flurry of activity between consumers and retailers can be played a variety of ways in terms of investments, today we're going to look at a company that assists in the exchange of that currency: American Express.
American Express is a traditional credit card company with a twist. While they provide the regular services one would expect from a financial services company of their ilk (credit cards, check services, etc etc.) they have been able to create a business model that, over the years, has turned into an engine of profitability. American Express has been able to attract a large base of big spenders. They do this by offering rewards and services for frequently purchasing products with their cards and services. These customers are, in turn, attractive to merchants, as they generally spend a lot and buy often. This allows American Express to request high discount fees from the merchants, which they then use to fund their rewards programs. Which makes their products more appealing to big spenders, and thus the cycle continues to go round.
This "closed-loop network" provides American Express with two things, both of which we believe are integral in providing the company with the tools required to compete with the future growth of mobile/alternate payment options. First, the closed-loop network helps provide AXP with a wide economic moat. It is hard to break satisfied customers away from a product, and the rewards programs and services AXP offers helps keep their affluent customers happy, thereby keeping merchants on their side. Average annual spending on AXP cards is much larger than the amount spent on competitor's cards, which makes the brand more attractive to merchants, and therefore stronger and harder to subvert. Secondly, the closed-loop network provides AXP with a massive amount of consumer data, as they issue cards to both consumers and merchants. This allows them to track the spending habits of its cardholders in a way most card companies can not. The company is still in the early stages of monetizing this data, but we think it will be invaluable to retailers, and therefore, profitable for AXP.
AXP also has a significant portion of the electronic spending pie, an expanding market that will continue to grow for years to come.
This is not to say that the company is without challenges though. Mobile payments are gaining huge momentum and will change the way we buy and sell products and services in ways we can only yet imagine. AXP has some resilience due to their closed-loop network, but in terms of overall strategies we believe that it is only a matter of time before mobile payments become the new norm. That said, AXP is well positioned to maintain a significant share of the market pie for years to come, and has the innovation and the potential to get into the mobile payment space themselves.
While we are positive on AXP's outlook despite the growing mobile payment space (of which we have yet to see any true top-dog or market standard), we are a bit cautious for our Covered Call Strategy on AXP at the moment. Technically, the stock just broke out of its buy range back in October, and while going higher, is showing signs of momentum loss. While the 2013 EPS growth estimates are at 11%, they were just recently revised downwards slightly, and the stock has not developed a strong new support level after its breakout, leaving the 50-day moving average (at approximately $79) and then the previous resistance level of about $77.90 as the next two levels of support. We are bullish on AXP, but will sell an in-the-money Call on the stock to receive a healthy premium and decent downside protection on the stock. If the stock continues to climb, we still pick up a decent yield on our strategy with a relative measure of safety. If the stock pulls back to previous support levels, we get to hold on to what we believe is a good investment, at a more reasonable cost basis. That is why we are recommending buying AXP and selling the April 2014 $82.50 in-the-money Call.
- Buy 100 shares of AXP @ $84.18 = $8,418 + Commission ($12.95) = $8,430.95
- Write 1 AXP April 2014 $82.50 Call @ $4.90 - Commission ($8.70) = $481.30
Note: Prices may vary from the time of post. Actual commissions paid will vary returns.
Static Return (Not Called):
(Call + Dividend)/Stock Price X (Days/Year)/Days to Expiration
(4.81 + (2*0.23))/84.31 X (365)/143
= 15.95% Static Return
(Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration
(4.81 + (2*0.23) + 82.50 - 84.31)/84.31 X (365)/143
= 10.47% If-Called Return
Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarantee the above, or any, result. All investment decisions should be made based upon individual's personal investment goals and risk tolerance.
Disclosure: I am long AXP.
Additional disclosure: OakTree is an active manager and may increase or decrease positions as markets dictate.