On its recent earnings call, American Express (NYSE:AXP) dedicated a lot of time answering questions regarding its imminent divorce from Costco in the United States. American Express has long been the provider of the sole Costco-branded card TrueEarnings Card from Costco, which is also responsible for a large proportion of the credit card company's transaction volume. Beginning in 2016, Citigroup (NYSE:C), through its Citicards division, and Visa (NYSE:V) will take over the Costco-branded business. 

The impending loss of the U.S. co-branding opportunity comes shortly after Costco Canada stopped accepting American Express-branded cards on January 1, 2015. The U.S. Costco business is noticeably larger, representing 8% of global billable business and 20% of AXP's current loan portfolio. With Costco-branded card business representing such a big piece, American Express investors have a right to be worried. 

A closer look at Costco & American Express
If there is a silver lining in the negative news, it is in how Costco cardholders are using their cards currently. While the TrueEarnings card is closely associated with membership and purchases made at Costco, the card was popular in many other areas. Offering up to 3% cash back on gas (making it one of the best gas credit cards) and 2% on travel purchases and U.S. restaurants, consumers frequently used the card on purchases outside the store. According to American Express, non-store purchases accounted for 70% of all spending on the co-branded card. It's no surprise this card is one of the favorites among personal finance bloggers.

This high percentage of outside spend is positive news for the card issuer, as it represents spending that the company could retain going forward. Ironically, the lucrative rewards of the current card probably contributed to dissolution of the relationship. Reports indicate that the impasse between AmEx and Costco came down to fees charged by the issuer. These transaction costs directly fund rewards offered to cardholders. In many ways, Costco ended up subsidizing the benefits accrued on non-store spend.

With the new agreement is supposed to reduce bank-related fees to near zero, Citi and Visa are hoping that the new Costco relationship will pay for itself through greater out-of-store spend. But this might not play out as the two companies hope. Reducing transaction costs to Costco will likely also mean a reduction in some of the rewards and incentives built into the current card. We think it is likely the card's rewards structure was largely responsible for the high non-Costco spend. Given similar incentives in other cards, these consumers might be convinced to remain American Express card members.

In response to losing its Canadian relationships, for instance, the issuer did just that, offering a new cash-back credit card as part of its retention strategy. While short on details, management has indicated it will focus on capitalizing on its existing cardholder relationships. Investors should begin to see Costco's impact toward the end of this year, with the largest effects beginning once 2016 rolls around. It is also possible management could sell the existing loan portfolio, which would free up capital for future investments. At this point, that possibility is not included in any of the company's guidance scenarios.

Long-term card competition an issue for American Express
While American Express still has a strong brand, the loss of the Costco partnership along with the end of its JetBlue relationship raise questions about the company's long-term strategy. As other card issuers have moved increasingly toward co-branding opportunities, American Express has, in recent years, instead seen a reduction in partnerships. Among airlines, only Delta remains in its U.S. portfolio, representing a significant portion of overall card spend. Meanwhile, the Starwood Card is one of the bright spots for the company in the hotel space.

In the past, the company's line of charge cards, especially the Platinum Card incorporate a suite of travel-related perks such as lounge access with different airlines. Over time, airlines have revoked such privileges, instead providing them through their own co-branded offerings through other issuers. Left with fewer perks, the company has attempted to shore up these weaknesses by investing in its own Centurion Lounges.

The problem for the company is that as consumers become increasingly used to sophisticated credit card and travel rewards, there is little it can do short of offering cards with similar rewards rates. Currently, however, few if any of the company's cards compare adequately to those of other issuers. In American Express's portfolio, only the Starwood card and soon-to-be-discontinued Costco card rate as must-haves among rewards-focused consumers.

In the cash-back category, the company is particularly weak. If the company is really intent on retaining non-store spend among Costco cardholders, we think it will need to come up with a new cash-back card that might act as a replacement. This would be a departure from the card structures the company currently has, as it would need to be significantly better than any existing options.

This article was originally published on Value Penguin.

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