On this episode of Industry Focus: Financials, Fool.com contributor Matt Frankel, CFP, sits down with Gunther Bright, executive vice president, merchant services U.S., for American Express (NYSE:AXP) to discuss how Amex has evolved in recent years. Afterward, Frankel and host Jason Moser discuss earnings from Bank of America (NYSE:BAC), Morgan Stanley (NYSE:MS), and Travelers (NYSE:TRV) and answer a listener question about investing in wealth management firms. And, as always, we close out the show with two stocks we're keeping our eye on now.
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This video was recorded on April 22, 2019.
Jason Moser: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market each day. It's Monday, April 22nd. I'm your host, Jason Moser. On today's show, we've got some earnings to get to. We're going to answer a listener email. We'll tap into Twitter. As always, we've got One to Watch. But we begin this week with another installment of Between Two Fools. For more than 13 years, Gunther Bright has been working for American Express, managing everything from global clients to co-branded partnerships. Today, Gunther is the executive vice president of U.S. merchant services with American Express. Recently, our own Matt Frankel chatted with Gunther about the steps that American Express has taken to become more universally accepted and more merchant friendly and the current and future state of the payment-processing business.
Matt Frankel: The reason that you guys really landed on our radar for this podcast is that Amex pointed out that they not only have brought fees down for merchants in recent years, but they're much more universally accepted. Personally, I carry an Amex in my wallet. I've noticed that I don't have to pull out my backup credit card in as many places as I did a few years ago, Amex is definitely more universally accepted. How has Amex addressed the problem of universal acceptance?
Gunther Bright: Matt, I'm glad you're having a better cardmember experience at the point of sale, the merchants. That's intentional. It's a few things. At a high level, you asked the question, how many more merchants are accepted. Over the last two years, three million incremental merchants are accepting the American Express card in the U.S. What we did is, when we were thinking about the gap of acceptance, we really had focused our attention on small merchants, which make up the majority of our merchants in the U.S. And they were two things that we really tried to identify in terms of pain points. One was the ease of acceptance. The next one was price. Let me talk about ease of acceptance. It was really the experience for these small merchants before, if they wanted to accept American Express, they had to have one process of acceptance and enablement for other networks and a different one for American Express, which made it clunky, which made it difficult, which wasn't efficient. If you think about a small merchant, that is more work added to the process. They just didn't and don't have the infrastructure and the capabilities for that. We really wanted to make it where a processor had the ability to set up American Express at the same time they were setting up other networks. And that has been extraordinarily helpful in accelerating our coverage and reducing the gap that you had experienced years past.
The next one was price, which was a pain point for small merchants. What we did is really better understand and revisit the price that we were charging merchants and make sure that it was commensurate with the value that we were delivering. That price is based on the industry. It's based on how much spend goes there, etc. But, really making sure that the price was set. We have that price established. And now, at the point of the processor that I mentioned, they actually set the ultimate price for the merchant. We gave that processor a certain rate -- again, based on the industry and the value.
So those two things, ease of acceptance that we addressed, and making sure our price is commensurate with the value that we deliver, were two things that really made a difference in terms of more universal coverage for American Express.
Frankel: You mentioned price there. I used to run a small business years ago. American Express cost us significantly more to accept than Visa or MasterCard. I understand that you've revisited your price. Specifically though, can you comment on how the gap has narrowed between you and the other major networks?
Bright: Yes. Not sure how long ago, Matt, you're talking about with the price, because before, frankly, American Express did have a premium as it relates to price. That said, over the last 10 years, our price has been going down while other networks' prices have been going up. Where we are now, on average, the prices between us and other networks are pretty commensurate. They're comparable. That's where we are now. We did that by addressing, again, the value we're delivering to a particular merchant within a particular industry. Our price now, we go out and price for merchants all the time on an aggregate but also on an individual level. Again, where we've seen that a high price is not warranted, that's not where we would price that way. A large part of our pricing is on the profitability that we deliver to that merchant based on the customers that visit that particular establishment. As you know, American Express has the more affluent customers, and the way that manifests itself for a merchant, if a person has an American Express card, they spend 3 times more than you would if you had another card, you transact at that particular establishment 1.7 times more. So we're really trying to make sure that the price that we charge a merchant is warranted by the types of cardmembers that come in. Again, I just described the demographics of the American Express cardmember.
Frankel: American Express, over the past decade or so, I think it's fair to say it's become a broader spectrum of credit card products, not just focused on the premium customers. Do you have prepaid cards, the no annual fee credit cards, things like that?
Bright: That's correct.
Frankel: But your flagship products are still high end -- the Platinum card and things like that. Do you still see American Express's focus to be on higher-end credit cards? Or do you see it becoming a more broad-based credit card business over the years?
Bright: A couple of things. One, really the value for our customer hasn't changed in terms of the targeting that we go after. We continue to believe in cardmember options. Matt, we have in the U.S. over 30 different products, from no fee to fees, that we have available for prospective cardmembers and existing cardmembers to choose from. We think about the products, when we're doing the construct, what is the cardmember looking for? Some, as you know, have an aversion to fees, so we have no-fee products, and rewards aren't that important to them. Others, we have products for people who are focused on travel, they have different aspirations, whether it's, "I like to dine, I like to travel. I like the lounge experience when I'm traveling." We make sure that the products that we put in the marketplace is consistent with the demand we see, but also that we are focusing and targeting certain customers. That has resulted in a broadened cardmember base. The fastest-growing demographic for American Express are millennials. Millennials right now, the last two, three years, have been our fastest-growing segment. That's frankly because of the benefits and the value that we embed in different cards.
Frankel: That's definitely very interesting. So in general, the fees in financial services have gone down in the past decade or so. First of all, has this been the case in the credit card industry overall? You mentioned that American Express is definitely more comparable with Visa and MasterCard. Has the overall trend been downward? Do you see the credit card business being pressured, I guess, if you will, by the anti-fee nature of the financial service business?
Bright: The pressure always is going to be on downward pressure on price. But again, what I'll go back to is, we made and continue to make a conscious effort to have our price match the value that we deliver. I go back to match the profitability that we deliver to that particular merchant. Again, we think about, in the simplest form, which industry this merchant is in, how much cardmember spend from American Express is there. And then really making sure that it's understood to the merchant that's actually a good thing to accept American Express because of the type of cardmember that we deliver there. We also have insights, we have data that we provide, because of our integrated system, meaning we have close relationships with merchants, close relationships with cardmembers, where we're able to give certain insights. Just recently, last week, I had a discussion with a well-known national retailer where, of course, price came up as part of a discussion. We were able to walk through the data. This, by the way, was the president of a company as well as the CFO. We were able to walk through the data and explain to those two individuals, "This is why you want to accept American Express. This is why we charge what we charge." Frankly, they were surprised by the profitability of an American Express cardmember vis-a-vis other competitors, other networks. That really resulted in them, frankly, asking for more cardmembers, and how can we help them from a marketing perspective in leveraging our channels to increase same-store sales for them. That's how the conversation typically ends. Again, because we have unique data and insights, we can give them information that tells them, "Here are our cardmembers that spend with you. Here are our cardmembers that spend with some of your competitors. Here are our cardmembers that are more loyal with you or more loyal to your competitor. How do we drive more store sales to you based on the insights that we have, the marketing we can do, and the joint efforts of offers, etc., that we can deliver to our cardmembers?"
Frankel: In other words, as long as you continue to come up with innovative ways to create value for your customers, you don't really see your pricing coming under pressure that much, as long as you're delivering acceptable value for it.
Bright: I think it's too easy to say we don't see the pressure of price. Price continues to be a pressure. But what we do is, we get ahead of it. We stay, I would say, in an anticipatory mode of thinking, how can we continue to justify and rejustify the price that we charge and continue, frankly, to educate and work with our merchants so they have an understanding of the price value equation that we have. Frankly, once the profitability is understood, typically there is less concern about the price, and there's not a focus on the few basis points that we may be, may be, more expensive. Again, I've told you that on average, we're comparable to other networks. But where we do have a differential and it's a premium, they understand that, boy, this is so worth it, again, given the demographics and given the cardmembers and given the insight that American Express delivers versus other networks.
Frankel: One of the things I found that was really interesting when I was doing research for this interview was that it costs the merchant about one-third of the amount to accept a debit card as it does a credit card on average. Can you help our listeners understand why that is? Is it the value you create? Is it just more of a process to process a credit card transaction versus a debit card transaction? Can you enlighten us on that?
Bright: Yes. That is a correct observation, that debit cards are less expensive for merchants than other cards. But that is really a function of the base benefits that you get. You get no benefits with the debit card, versus the benefits that are embedded in other credit cards and other card products. In a big part, that is what drives the differential in price.
The other thing is that from processing that transaction, a debit card is directly linked to the bank, so the processing of the transaction is easier. With a credit card, it goes through more iterations. That primarily would drive the different in the fee for debit versus credit card.
Frankel: One last thing before we let you go. A lot of our podcast listeners are avid readers. We definitely do episodes every so often just on the best books to read for personal finance and investing and everything. Can you recommend one of your personal favorites before we let you go?
Bright: Well, I don't have a personal finance one. But I'm just about finished with a book that I'm reading now, Eternal Life by Dara Horn. It's really quickly about a woman who lived to be 2,000 years old. And just how would your paradigm change if you can live kind of forever, 2,000 years, versus the paradigm that we have that life is finite. It talks about the options that you would make that's different versus, again, if there wasn't a finite date that you saw, versus you had a longevity of thousands of years. It just really focuses you on, how do you live life in today and in the moment and extract the most from it. So that's what I would encourage your readers to at least look up. Again, Eternal Life by Dara Horn.
Frankel: That actually sounds fascinating and I'm probably going to order that as soon as we get out of the studio. Gunther, thank you so much for taking the time and explaining what's new at American Express and how the business is going and how some of the inner workings of the credit card business work.
Bright: Was my absolute pleasure, Matt! Be well!
Moser: Now, as if just stepping out from the interview himself, I'm welcoming into our studio via Skype, Certified Financial Planner, Matt Frankel. Matt nice interview you had there with Gunther!
Frankel: Thank you! I learned a lot. Hopefully the listeners did as well.
Moser: I think they probably did the technical term for what you did there, Matt, is you hit them with the Hein. You did a great job! Good job, buddy!
We're going to get into some earnings here today. We've got Earningspalooza really kicking in full gear. We've got Bank of America, Morgan Stanley, Travelers on our radar today. Matt, tell our listeners the two-minute drill for Bank of America's earnings -- the good, the bad, the ugly, and what they need to be caring about.
Frankel: Bank of America, like most of the other banks, beat earnings estimates. That's not really out of the ordinary. Most banks have been beating earnings estimates, especially since tax reform was passed last year. In addition to that, we saw the right numbers. Interest margins expanded, as would be expected with rising interest rates. Bank of America's profits are getting better. Efficiency has gotten a lot better. Their efficiency ratio dropped from 60% to 57% over the past year. 57% is really good for a big brick and mortar bank. That puts them definitely in the elite category. In addition to that, they're buying back stock aggressively, like most other big banks are. They bought back more than 2% of their outstanding shares in the first quarter alone. Normally, when companies do a buyback, 2% is a good rate for the whole year. And they did it in the first quarter. That's definitely a big positive. They're doing really good embracing technology and building out their mobile users, which is a big cost saver. Had a lot to do with that efficiency ratio. Mobile banking users rose 9% year over year, and this keeps going up and up and up. It's going to make them very competitive if it keeps going.
Moser: A reminder for listeners, that efficiency ratio, which is a key metric to focus on with the banking industry, it tells us how the bank is managing its expenses. The lower the number, the better, right?
Frankel: Right. That means they're spending $0.57 to generate every dollar in revenue essentially, is what that means.
Moser: All right, makes sense. What about Morgan Stanley, another big bank out there? What'd you see with their recent report?
Frankel: That's another one that beat on both the top and bottom lines. Morgan Stanley's numbers looked really good throughout the business, even compared with some of their competitors. They actually beat expectations for trading revenue, which was a big problem in, say, Goldman Sachs' earnings report. Investment banking revenue dropped but did as well as expected. The big reason for investment banking drop -- this is a key point for investors in Morgan Stanley or Goldman Sachs to know -- merger and acquisitions and IPOs have been in a lull lately. In the first quarter, IPO activity was very low. Now, as the second quarter starts, you're seeing a wave of IPOs. We just saw Lyft a little while ago, Pinterest, Zoom, Uber's coming up. Don't read too much into the fact that investment banking revenue really plummeted during the first quarter. There was a reason for it, but it's looking like a temporary reason. It looks like IPOs are going to be the buzzword for the rest of 2019. It could be a big catalyst for those two banks.
Moser: OK. Looks like a pretty decent start to the year for a lot of the banks that we are covering. Going a little bit across the aisle here into the insurance business, Travelers, which is one that I had as my One to Watch last week, I believe, reported. I feel like if you're a Travelers shareholder, then you need to feel really good about the fact that you own these shares. It continues to be a very well managed business that is not trying to overreach. It's not trying to grow too quickly by writing bad business. Net premiums were up 3%. A good indicator that they're growing, but it's controlled growth. Strong underwriting gains, reflecting that smart decision making. The underlying combined ratio for the business was 91.6% versus 92.4% a year ago. We talk about ratios for banks. Well, for insurance, that combined ratio is an important one, because it tells us essentially how well they're writing that book. The lower the number, the better. Anything over 100 tells us basically that they're losing money on the business that they're writing. It's worth noting that the underlying combined ratio that they refer to, underlying means that that excludes the impacts of catastrophes. Catastrophes can make the insurance business a little lumpy. Underlying gives us a little bit more of an idea of how things are going on a quarter-to-quarter basis. Regardless, I think it was a good quarter.
The stock trades around a 1.5 times book value today. I like this company a lot. I think it's a great holding for folks out there wanting to get insurance into their portfolio. I don't think I'd be buying it at today's valuation simply because of the valuation. But I imagine that we'll find a time here sooner or later where that stock will pull back either due to general market conditions or perhaps some events out there that play out on their book that perhaps bring the stock price back a little bit. Definitely one worth keeping on the watch list there. It's good enough for Berkshire, Matt. We talked about that before.
Frankel: Yeah. Anything good enough for Uncle Warren's good enough for us. At the right price, that is.
Moser: Right, at the right price. Good addendum there.
I want to tap into Twitter really quick. Just had a couple of tweets that I wanted to note here from at @OneShotStevie. OneShotStevie asked, "How do I ask you the question for The Motley Fool podcast? I'm very interested to hear an updated opinion on Uxin. Thanks." I'm sure I botched the pronunciation of that company. That is a Chinese used-car business, used-car platform. OneShotStevie, I am happy to tell you that next Tuesday, I will be hosting the Industry Focus: Consumer Goods show. I have managed to talk Emily Flippen, one of our analysts here on the investing team, to come in and do the show with us. She's going to give us an update on Uxin. Look forward to that soon. Hopefully she'll be able to give you a good updated take on the state of the business. I know there was a recent short report out there. She'll have a couple of things to say about that, I'm sure.
We also had a tweet from @The_ChantillyFR. This was just a nice shout-out honestly. He says his favorite business podcasts, and he goes on to list a few podcasts there. At the top of his list are Market Foolery, Industry Focus, Motley Fool Money. I mean, wow! Those are some really kind words there. Really appreciate the nice words there from @The_ChantillyFR.
Now, Matt, let's jump into an email that we got a little while back from a listener, Chip Hockenberry wrote to us. He says, "I'm curious to hear your thoughts on the wealth management sector. 2018 was a very down year for the industry. There's been a lot of movement into passive funds in recent years, which may be catching up to these predominantly active managers. But BlackRock is a leader in the passive space and was still down significantly. Another interesting piece has been the acquisitive nature of all of these firms that don't seem to be paying dues in the stock price." Matt, we talked a little bit about this on Slack before the show. What you make of this for Chip?
Frankel: For the wealth management stocks, there's three points you need to know when it comes to why they performed so poorly last year, and just general business dynamics going forward. First, these businesses primarily make money off management fees. If their assets under management decline, whether by people pulling money out, or by just overall market declines, as we saw last year, it's going to cause profits to suffer. In BlackRock's case, for example, assets under management wound up declining 5% during the fourth quarter just because of poor market performance. As a result, revenues declined by 9%. That would cause BlackRock to take a big hit, even though you're talking the passive game.
That's No. 2. A lot of investors, the trend is moving from active investments to passive investments. A lot of firms offer both types of investments. Even if assets under management remain equal, a lot more is going to passive investments, which usually carries much lower management fees. That could be a big revenue hit as well.
And then third, there's a big trend in the industry toward lower fees in general. People don't want to pay more than 1% for an actively managed mutual fund. People think that index funds should cost next to nothing. As each of these firms are competing with each other, both in the active game and passive game, you're seeing a lot of pricing pressure. Fidelity is offering pretty much free index funds. You get a great Vanguard or Schwab fund that charges 0.03% or 0.04% of assets under management, which is almost nothing. There's a lot of pricing pressure in the industry right now, which is not only act actually being reflected in the numbers right now but is causing investors to be worried about the earning power of these companies going forward.
So when you're looking at these stocks, I would say those three things are what you want to look at.
Moser: All right, good stuff. I hope that was helpful for you, Chip! I know it was helpful for me. Thanks, Chip, for the email! Really do appreciate that! Folks, you can always reach out to us on Twitter @MFIndustryFocus whenever you have any questions. We're more than happy to take it for you, we'll try to bring it on the show whenever we can.
With that in mind, Matt, let's go ahead and wrap it up this week here with our Ones to Watch. What's on your radar this coming week?
Frankel: Being that I'm a real estate guy at heart, I'm going to mention one of my real estate investment trusts or REITs, Tanger Outlets. If you're an outlet shopper, you've probably heard of the company. Retail REITs continue to be under pressure just because of general headwinds in the sector. Interest rates have ticked up a little bit recently, which has put pressure on all REITs. Tanger is actually at a 52-week low despite the fact that it's, in my opinion, one of the best ways to play retail. Right now, the stock pays about 7.5%, so you're getting paid very nicely while you wait for the sector issues to play out. That's what I'm watching, especially at these prices. I might jump in and buy a little bit more. I already own a lot of it.
Moser: All right. I'm going to go a little unconventional this week with Chipotle. The stock itself is up somewhere in the neighborhood of 65% for the year. It's been on fire, for good reason. I think CEO Brian Niccol has certainly taken this business in a new direction, one that's resonating with consumers and investors. Earnings come out on Wednesday the 24th. The main reason why I'm focused on it is because we see a lot more we in the mobile experience, and therefore the mobile payments that are going through their app, as they're building this business for the mobile consumer, the to-go consumer. Last quarter, digital sales grew 65.6%, accounted for almost 13% of sales. I'll be interested to see how those numbers are shaping up here. Again, they've made it so easy in the app to order. You have a number of different ways that you can pay now on those apps -- Apple Pay or your credit card that you have loaded in the app there. It really does seem like new leadership here at Chipotle has lit a little bit of a fire under the business, got things going in the right direction. I'll be looking forward to that.
Matt, listen, I guess that's going to wrap it up for us this week. You've got another interview on tap for us next week. Right?
Frankel: Yes, we'll be speaking with the Marcus by Goldman Sachs team in honor of Financial Literacy Month, which is April.
Moser: That sounds good, Matt! We'll look forward to talking to you next week! Then thanks again for joining us this week, as always!
Frankel: It's always fun to be here! Hopefully I'll get back up to the studio soon.
Moser: Soon enough! As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Today's show was produced by Dan Boyd. For Matt Frankel and Gunther Bright, I'm Jason Moser. Thanks for listening! And we'll see you next week!
Jason Moser owns shares of Apple, Chipotle Mexican Grill, Mastercard, Twitter, and Visa. Matthew Frankel, CFP owns shares of American Express, Apple, Bank of America, Berkshire Hathaway (B shares), and Tanger Factory Outlet Centers. The Motley Fool owns shares of and recommends Apple, Berkshire Hathaway (B shares), Chipotle Mexican Grill, Mastercard, Twitter, and Visa. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends Tanger Factory Outlet Centers and Uxin Ltd. The Motley Fool has a disclosure policy.