The payments and credit card company American Express (AXP 0.57%) just reported monster results for the second quarter of the year, growing revenue by more than 30% on a year-over-year basis and adding a record 3.2 million new cards in the quarter. While the stock always tends to trade at more of a premium valuation, investors may be growing increasingly concerned about the company because it heavily serves the consumer, which soon may find itself in a recession. Let's take a look at how American Express might fare during a recession.
Understanding American Express' business
American Express has one of the most enviable credit card brands in the world, allowing it to charge subscription fees on several of its credit card products. The bank also makes money on credit card loans, which totaled nearly $100 billion at the end of the second quarter. Being in the credit card business obviously exposes the company to the consumer, who can struggle during a recession and lead to higher loan losses.
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But while American Express has a large loan book, income generated from those loans only made up roughly 18% of the company's total revenue in the second quarter of the year. American Express made 59% of its revenue from discount revenue, which comes from the fees it earns from facilitating transactions between the merchants and card members on its payments network. Almost every business that accepts credit cards can accept American Express, and the company's payments network saw nearly $395 billion of volume in the second quarter.
While consumer credit companies can struggle with inflation, payment networks can fare better because when items cost more, American Express earns higher percentage-based fees and generates more discount revenue. While higher interest rates can increase loan defaults, American Express serves a higher-quality customer base than many competitors, many of which are super-prime customers. However, in a severe recession, the company would likely see higher loan default rates and less spending across its network.
But another thing American Express has going for it is the fact that travel and entertainment spending, an area the company excels in, has been significantly ramping up in the second quarter even as economic growth has become weaker. It's unclear how long this might last, but American Express CEO Stephen Squeri, on the company's recent earnings call, said he doesn't anticipate travel and entertainment demand abating any time soon.
American Express has been stress tested
American Express also came out as one of the top performers in the Federal Reserve's annual stress-testing exercise this year, in which the Fed puts the largest banks in the country through a severe hypothetical economic situation to ensure the banking system is on sound footing.
Under a severe nine-quarter timeline, in which unemployment rises above 10%, commercial real estate prices fall 40%, and stock prices fall 55%, American Express would maintain healthy levels of capital, take about $14 billion of loan losses, and generate a pre-tax profit of more than $5 billion. Of the 33 banks put through this year's stress test, only one other reported a higher profit than American Express. CFO Jeff Campbell also noted that, in stress testing, American Express had the highest profit margin as a percentage of assets of all 33 participants.
Management said on its recent earnings call that the company is preparing for deteriorating economic conditions, despite not seeing credit deterioration in its customer base through the first half of the year. Even though American Express management has raised its full-year revenue guidance, it maintained its full-year earnings guidance, acknowledging that it may have to set more reserves aside for loan losses later this year.
Is American Express a good stock to own in a recession?
Credit card companies are not ideal investments with a recession potentially on the horizon. But American Express is so much more than your ordinary credit card company when you consider its high-quality customer base, the strong brand which allows it to charge subscription fees on its products, and the payments network, which can actually hedge inflation to a certain extent. American Express would likely take a hit during a severe recession, but given its stress-testing results and growth potential, it's a good stock to own for the long haul, even if there is a recession at some point.
