The payment processor and credit card issuer American Express (AXP 10.54%) has long been one of Warren Buffett's favorite stocks. Just last year, Buffett called the brand special, and American Express is currently one of Berkshire Hathaway's (BRK.A 0.01%) (BRK.B -0.57%) top holdings in its equities portfolio. The stock has spent much of 2021 hitting new highs and is currently trading up more than 50% this year. Can it keep going? Let's take a look.
The business has been rebounding
With a lot of business in the travel and entertainment (T&E) and retail sectors, American Express was certainly affected by the pandemic, which hit many of those sectors hard. But for the first time since the pandemic hit, spending on American Express cards is up from the third quarter of 2019. This drove discount revenue (transaction fees American Express earns from merchants that accept its cards and one of the largest drivers of revenue at the company) to nearly $6.7 billion, up slightly from 2019.
That's very good when you consider that T&E spending on American Express cards is still down 29% compared to 2019 levels. Management expects T&E spending to recover to 80% of 2019 levels by the end of the year. Picking up the slack has been spending on goods and services, which is up 19% compared to 2019. Americans are clearly spending again, and the costs of many goods and services have increased over the past year and compared to 2019.
Another interesting part of the rebound is that it's being fueled by younger folks. Millennials and Gen Z spent 38% more on American Express cards in Q3 compared to the same quarter in 2019. In comparison, Gen-X spending only rose 9%, while baby boomers' spending was down 6% compared to 2019.
On the loan front, the company saw some signs of a rebound, as total credit card loan volumes rose about 2% sequentially, but are still down about 10% from the third quarter of 2019. Management attributed muted loan growth to the financial strength of the customer, which has resulted in stronger levels of cash and paying off loan balances at higher rates.
The flip side to muted loan growth has been strong credit quality. For the third quarter in a row, American Express was able to release capital previously stored away for loan losses, which helped juice earnings. Additionally, the company recently raised the annual membership fee on its platinum card from $550 per year to $695 and is growing net card fees as well as new cardmembers.
The rebound enabled American Express to generate $2.27 diluted earnings per share on total revenue of nearly $11 billion. Revenue is the highest it's been in five quarters, but pre-tax, pre-provision revenue, which removes the noise from reserve releases, was down slightly from each of the first two quarters of the year.
Valuing American Express
American Express is unique because it's a payment processor and has set up a rail network like Visa (V 3.00%) and Mastercard (MA -0.85%), but it also makes loans and takes on exposure like Capital One (COF 1.30%) and Synchrony Financial (SYF 1.40%). It's most similar to Discover Financial Services (DFS 2.51%), although considered a much better company.
As a result, American Express trades at a multiple in between the processors and card issuers. In 2022, management is projecting earnings per share to come in toward the higher end of what were its initial projections for 2020 before coronavirus hit. That EPS range was $8.85 to $9.25. If you take American Express' current multiple of 18.8 and multiply it by the high end of guidance ($9.25), you would arrive at a share price of about $174, which American Express has already surpassed.
However, if you assign American Express a multiple roughly in between the two groups of companies it is most similar to, which I will do by taking the average of the multiples between the highest card issuer (Discover) and lowest payment processor (Mastercard), American Express would have a multiple of 21.65. That would imply a share price of about $200, or 11% upside from current levels if management can hit its earnings projections for 2022.
What to consider
American Express' business is still recovering and could recover further in 2022 if T&E spending continues to rebound. I'll also be watching how American Express does with new card-member acquisition, considering that expenses have been elevated lately and the company has increased the annual subscription fee for members. Ultimately, the stock price has run up a lot, and there doesn't look to be a ton of upside in the near term. But Buffett is certainly right when he says that the American Express brand is special, and I think long term the stock can continue to produce good returns for investors.