Last week, American Express (NYSE:AXP) reported its first-quarter earnings. Like many of the other big banks, the company reported a large provision for loan losses in the first quarter, as the COVID-19 global recession took its toll, with a growing portion of American consumers and small businesses unable to pay their credit card bills.
However, American Express isn't primarily a lender. It's also its own card network, earning a discount fee every time a merchant swipes an American Express card. In fact, Amex's discount revenue equated to 60% of total revenue last year, whereas net interest income on loans only made up 19.8% of revenue, with card fees and commissions making up most of the remainder.
Of course, the discount fee business is also going to feel the pain, as people pull back heavily on spending. Worse for American Express, it has a relatively large travel and entertainment book of business, since it's a premium brand that mostly appeals to wealthier, prime or super-prime customers. That usually provides steadily rising discount revenue in normal times, but these are anything but.
With American Express set to take a big hit this year on all parts of its business, its stock has cratered some 40% from its 52-week high. While some of that decline is no doubt warranted, American Express is still a premium brand catering to a high-end clientele. Is the stock a contrarian buy at this point?
During the first quarter, American Express showed the effects of a severe March downturn. Those two weeks took a toll on the company's bottom line. However, without the company's $1.7 billion extra reserve builds, earnings per share would have shown positive growth over the prior year:
|Metric (in Millions)||Q1 2020||Q1 2019||Change (YOY)|
|Earnings per share||$0.41||$1.80||(77%)|
|Earnings per share excluding reserve builds||$1.98||$1.80||10%|
Still, these relatively benign results don't capture the deterioration of American Express's business in late March and into April. Weekly volume declines accelerated in March and have stabilized in early April, but at a pretty ugly number: 45% lower than before the COVID-19 outbreak. Roughly 30% of American Express's business is in travel and entertainment spending, and that segment saw a stunning 95% decline:
Not only are payment volumes plummeting, but on the conference call with analysts, management also said it could take even more reserves in the next quarter. That's because economic predictions have worsened since management closed the books on the March quarter. CFO Jeff Campbell said, "If those forecasts were to hold or even worsen by the time we close the books on the second quarter, we would expect to have another large reserve build."
Between low payment volumes and the potential for further reserve builds, American Express could very well dip into a loss next quarter.
Fortunately for American Express, the company has a number of things going for it. The list includes a rock-solid balance sheet, excellent management, and a great brand that appeals to well-off customers. These factors have contributed to American Express's steadily growing business in the past, and should help the company weather the current crisis.
On the balance sheet, American Express had a very solid 11.7% Common Equity Tier 1 ratio, up from 10.7% at the end of the fourth quarter. The upside of lower spending volumes is that American Express's loans and card receivables go down, meaning it has fewer risky assets on the books. Cash and securities also rose from $32 billion to $41 billion as loans fell and the company stopped share repurchases for the time being.
Management is also rightly focused on two things: protecting its employees, and protecting American Express's brand. Since the company appears to have the resources to weather the coming storm, American Express's high-touch, high-service brand should will allow for a strong recovery once the storm passes. Management was able to quickly restructure Amex products during the quarter, including discounts on e-commerce when members pay with points, double points awards for certain food delivery companies, and more rewards for stay-at-home services such as wireless services and shipping for small business customers.
For small business and corporate customers, management is extending the time businesses can have to respond to disputed charges. In addition, American Express implemented a customer pandemic relief program, allowing one to three months deferral on payments with no interest or late fees. So far, about 6% of loans and 8% of card receivables have asked for relief because of COVID-19. Management stressed that these are very good customers, with 88% in prime or super prime categories. Many of these customers have even made payments since enrolling.
Finally, there appears to be ample room for American Express to cut expenses. Management said that as revenue declines, Amex's costs of revenue decline by about 50% of revenue, so there is some variability there. In addition, management can cut even more from operating expenses, and the leadership team has identified $3 billion in cost cuts it can make this year. Management said it may reinvest some of those savings into key long-term initiatives should conditions allow for more spending. These variable costs and other savings should limit the damage this quarter and for the full year, allowing American Express to come through the other side of the crisis.
A Foolish Buy?
After its precipitous decline, American Express seems like a good value here. The company earned $7.99 in EPS during 2019, meaning the stock now trades at just aver 10 times its 2019 earnings, with a 2% dividend that should be very safe. Before the downturn, American Express had been a pretty steady grower in the mid-to-high single digits, with high returns on equity of roughly 30%, and nice share repurchases that lower Amex's share count. Though 2020 may be a "lost" year, American Express has the balance sheet strength and customer base to weather the crisis and maybe even take market share coming out of the downturn. For Foolish long-term investors, that means its a financial company you can safely buy today.