With the worldwide trend away from cash and checks and toward electronic forms of payment, companies that issue credit cards and provide payment services should have a bright future ahead of them, especially those with lots of international exposure.
American Express (NYSE: AXP), despite its name, actually derives about 30% of its revenue from international sources , which is one of the main things differentiating it from competitors such as Discover Financial Services (NYSE: DFS) and Capital One Financial (NYSE: COF). So, why do we care about American Express' international business, and what could it mean for the future?
The major credit card companies
When most people hear the term credit cards, they immediately think of companies such as Visa and MasterCard, so why aren't these businesses explored in this discussion? Unlike the others, Visa and MasterCard don't directly issue credit cards. Rather, they provide financial institutions with branded cards, and then facilitate electronic funds transfers throughout the world.
I'm more interested in the companies that directly issue credit cards. While they are more risky than companies like Visa, which generally gets a fixed percentage of a merchant's sales, credit card issuers have more potential upside.
Capital One, for example, is a bank holding company that specializes in credit cards but also offers home loans, auto loans, and other banking products. One of the largest direct issuers of cards, Capital One has credit card receivables of more than $78 billion. Trading at a relatively low valuation of just 9.5 times earnings, and right at its book value, Capital One does seem to be very fairly priced.
The lack of international exposure, however, is of some concern. A very small percentage of Capital One's credit card business is European, and most of this is cards issued to consumers with very poor credit ratings, which carry high annual percentage rates and high default rates.
Discover issues cards to about 50 million cardholders. While Discover's business is almost completely in the United States, it has an interesting growth strategy that makes it worth a look. The company recently launched a joint venture with PayPal, which is owned by eBay (NASDAQ: EBAY), whereby Discover provides a "mobile wallet" to PayPal's millions of customers.
Essentially, customers get a Discover-branded card linked to their PayPal account for shopping at physical retailers (traditionally, PayPal was an online form of payment). As this service has recently launched, it's worth watching to see how much it impacts Discover's bottom line.
A little about American Express
And now on to American Express, which not only issues cards, but provides payment, travel, and expense services all over the world. About half of American Express' business (51%) comes from its U.S. credit card business, which has grown tremendously as a result of excellent partnership arrangements, such as with Delta SkyMiles. The rest of AmEx's business comes from its global network and merchant services (17%), global commercial services (15%), and its international card services (16%), which is the area of the most growth potential.
What these percentages imply is that more than 76% of the company's credit card business comes from within the U.S. With electronic payments and charge cards still relatively new concepts in much of the developing world, and with AmEx already seen as a world leader, it has the most to gain as the rest of the world completes the same transition to electronic payments as the U.S. has over the past decade and a half.
A good buy?
While at first glance American Express doesn't look quite as cheap as the other companies mentioned, it offers an excellent value relative to its growth potential. While the long-term potential of credit cards and electronic payments in the developing world remains to be seen, in the near term, the consensus calls for earnings growth of about 12% annually over the next three years.
The company has a return on equity of almost 24%, well above the industry average. Return on equity, or ROE, is considered a good measure of how efficiently a company creates profits for its shareholders. Generally, an ROE of 15%-20% is considered to be very good.. To put this in perspective, Capital One has an ROE of 11.1%, which is typical for a banking company in today's market.
So, even though at first glance, American Express may seem a bit expensive, it also offers higher potential for profit over the long term.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends American Express, eBay, MasterCard, and Visa. The Motley Fool owns shares of eBay, MasterCard, and Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.