Paying a Premium for American Express Doesn't Matter When It's Doing All the Right Things

An improving U.S. consumer spending environment and shareholder orientation make American Express a Strong Buy.

Jun 23, 2014 at 6:00AM

Credit card companies such as American Express Company (NYSE:AXP) will be among the first businesses that benefit from cyclical tailwinds such as improving U.S. GDP growth, a lower unemployment rate and higher consumer spending as a result in the years ahead.

Add to that, American Express already experiences strong growth in its card business, makes progress in cutting costs and funnels decent amounts of cash back to shareholders and one can easily see why the credit card company has further potential to increase its equity valuation.

Cyclical tailwinds
There are a lot of reasons to be bullish on American Express. An improving U.S. economy and a lower unemployment rate are pretty much set to open up consumers' wallets in the coming years. The unemployment rate in the Unites States still stands at a relatively high 6.3% according to the U.S. Bureau of Labor Statistics and still remains above the long-term average of 5.8%.

Increasing confidence in one's economic prospects is the primary driver of U.S. consumer spending which still accounts for approximately two thirds of U.S. GDP. Higher consumer spending will translate into more business for American Express and, likely, higher share prices as well.

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Source: Wikimedia Commons

American Express' performance metrics are improving
American Express presented solid results throughout 2013. Performance metrics such as Billed Business, issued card numbers and member loans were all up and rising, indicating that momentum indeed is picking up for one of the largest credit card companies in the country.

Interestingly, over time, the U.S. has become a little less important for American Express to drive revenue growth, which is not really surprising as the United States generally is a fairly saturated credit card market. Nonetheless, the U.S. remains one of the most important markets for American Express.

In any case, American Express' Billed Business has been rising since the beginning of 2013 almost across all geographies and further growth should be ahead as the economy improves.

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Source: American Express Company Earnings Conference Call Presentation, April 16 2014

Cost cutting initiatives working
The U.S. credit card market has been fairly difficult since the financial crisis struck the United States with full force. Credit card companies ultimately exercised higher levels of due diligence and a tough operating environment pretty much forced American Express to turn to cost savings in order to deliver value for shareholders.

Rising operating expenses have been a constant headache for credit card companies and it wasn't until 2012 when American Express finally started to get a handle on its cost structure.

Total adjusted operating expenses stood at $10.7 billion in 2009 and at $12.7 billion in 2013.

First quarter 2014 results indicated, that American Express' adjusted operating costs are further coming down, freeing up more capital for the company to grow its business and to enact share repurchases.

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Source: American Express Company Earnings Conference Call Presentation, April 16 2014

Shareholder-oriented capital management
One of the key signs to identify a shareholder-friendly business relates to the willingness of a company to return excess capital to shareholders.

The graph below depicts American Express' payout ratio, the percentage of capital returned to shareholders in form of share repurchases and dividends, in each of the last four full financial years and in each of the last five quarters. The graph shows, that American Express oftentimes returned at least 69% of generated capital in each quarter since Q1 2013.

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Source: American Express Company Earnings Conference Call Presentation, April 16 2014

The Foolish Bottom Line
American Express is doing all the right things to increase its valuation while an improving U.S. economy should provide crucial tailwinds for American Express' core credit card business.

With better cost controls and outstanding shareholder orientation, it is easy to understand why Warren Buffett chose American Express as one of his cornerstone investments.

Warren Buffett just bought nearly 9 million shares of this company
Imagine a company that rents a very specific and valuable piece of machinery for $41,000 per hour (That's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report details this company that already has over 50% market share. Just click HERE to discover more about this industry-leading stock... and join Buffett in his quest for a veritable landslide of profits!

Kingkarn Amjaroen has no position in any stocks mentioned. The Motley Fool recommends American Express. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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