When the American Express Company (AXP 1.00%) reported its fourth-quarter earnings earlier this month, the credit card issuer proved its stellar 2017 was no fluke. Excluding the immediate and expected impact of the Tax Cuts and Job Act (more on that below), quarterly revenue rose to $8.84 billion, a 10% year-over-year increase, and earnings per share grew to $1.58, a 73% increase over 2016's Q4 adjusted figure.
The rise in revenue and earnings was driven by growth in Amex's loan portfolio: Total loans jumped 14% year over year to $76.1 billion. Its net write-off rate -- the percentage of loans that American Express does not expect to collect -- remained an industry-best 1.8%, though its provision for loan losses rose a sharp 33% to $833 million.
| Metrics | Q4 2017 | Q4 2016 | Change |
|---|---|---|---|
| Total revenue | $8.84 billion | $8.02 billion | 10% |
| Diluted EPS | $1.58* | $0.88 | 80% |
| Total loans | $76.1 billion | $66.7 billion | 14% |
| Loan-loss provisions | $833 million | $625 million | 33% |
Data source: American Express Company. *Adjusted for impacts of the recently enacted Tax Cuts and Job Act. EPS = earnings per share.
After reading through the conference call, as transcribed by S&P Global Market Intelligence, here are what I believe to be the three biggest takeaways from Amex's fourth quarter.
1. Short-term pain, long-term gain
Despite all the good news, American Express shares traded down the day after the company's earnings report revealed the suspension of its buyback program through the first half of 2018. Amex made the decision to free up funds to prepare for next year's Federal Reserve stress test. Those funds are needed because tax reform was passed in late 2017, and American Express recognized about $2.6 billion in charges on repatriated earnings and a remeasurement of tax-deferred assets.
American Express believes the recently enacted Tax Cut and Jobs Act will be a long-term catalyst for the company. Image source: Getty Images.
While this is understandably not great news for shareholders -- no one wants to see share buybacks suspended for half a year -- it is decidedly short-term in nature. Yet shares traded down despite CFO Jeffrey Campbell's repeated insistence that tax reform would be a positive catalyst for the company moving forward:
Of course, most importantly for the long term, the new tax law does significantly lower our tax rate going forward, which increases the capital-generating power of the business. Given the lower tax rate, we expect that, over time, we will more than make up for any reductions in the buyback in 2018 and generate more earnings and return more capital than we would have without tax reform.
Later, Campbell said employees, customers, and shareholders would all benefit from the future tax savings: Employees would be given increased retirement benefits, $200 million would be invested in customer-facing initiatives, and shareholders would see the remainder of the funds "build capital and support earnings growth."
2. Lower discount rates, higher revenue
Discount rates, or the fees merchants pay to credit card companies for card payments, typically run between 1% and 3%, with American Express historically near the top of that range. In the second half of 2017, its discount rate fell to 2.41%, down from 2.46% in the second half of 2016. When questioned by an analyst on this matter, Campbell said it was all about revenue growth as the company looked to significantly improve its merchant coverage.
The end objective here is to drive revenue growth. And we feel really good about the acceleration in revenue growth that we've achieved over the last 2 years. ... We are very consciously making some decisions that we think drive more revenue growth but also have the impact of bringing that discount rate down. So the decisions we're making around expanding coverage in the U.S. through the OptBlue program and some similar programs around the globe, some decisions we have made about how to best gain overall economics with some of our large partners have had a positive impact on revenue and a more challenging impact on the discount rate.
OptBlue is a program American Express started in order to increase its acceptance by smaller retailers. The program allows stores to shop rates for American Express acceptance and includes other perks like free window signage, placement on Amex's ShopSmall map, and even the ability to create free online ads. While this has driven down the discount rates American Express has historically been able to command, as Campbell aptly pointed out, it's about growing revenue.
3. Troubling loan-loss provision growth?
American Express maintained an exemplary 1.8% net write-off rate, but its loan-loss provisions -- money set aside for loans yet to be collected -- rose sharply to $833 million, causing some investors to worry that management sees further loan losses ahead. In a sense, this is correct and American Express has admitted as much.
American Express' loan-loss provisions have climbed steadily upward over the past year. Image source: American Express Company.
For starters, this is the result of the company's loan portfolio growth, which has been greater than the industry average for the past couple of years. It also stems from growing non-cobranded card loans with proprietary loan products -- think personal loans -- which inherently come with higher write-off rates. Another factor is the "seasoning effect" of some of the loans Amex has on the books: As loans reach a certain age, write-off rates begin to increase. Consider how few consumers start borrowing on a new credit card and immediately default.
Campbell maintains that this increase in loan-loss provisions is normal given these factors, and does not seem worried. Personal loans and other such products have higher write-off rates but come with higher pricing, too, to reflect the increased risk. At the end of the day, this produces "really good economics," Campbell said. It should be noted that net interest income did rise to $1.74 billion, a 23% increase over 2016's fourth quarter.
A buying opportunity?
If American Express continues to decline in share price as a result of these short-term headwinds, it could be one of those proverbial buying opportunities. While Wall Street remains laser-focused on the short-term effects of the newly passed tax legislation, it's hard to see how Amex management could be wrong in assessing the legislation as a long-term positive catalyst. And if a decrease in discount rates is accompanied by an increase in merchant coverage and leads to accelerated revenue growth, it's easy to see how that's yet another long-term positive for the credit card issuer. Finally, if American Express can capture more of its existing customers' borrowing power and net interest revenue continues to increase, then shareholders should not be overly concerned with the rise in loan-loss provisions at this time.
Given the company's guidance for revenue growth and an estimated EPS of $6.90 to $7.30 this year, shares don't seem too expensive. In fact, at the midpoint of this guidance, its forward P/E is only 13.8. At a projected growth of 7% to 8%, that does not seem overly expensive. I have already given the company a bullish call on my CAPS page, but I'm now considering buying shares in my brokerage account. If I were you, I would not let this high-quality name fall too much longer without giving it the same consideration.
