American Express: The High-Flyer of the Credit Card Elite
In the credit card industry, Visa (NYSE:V) and Mastercard (NYSE:MA) dominate with their massive transaction volumes, essentially forming a duopoly. Yet, American Express (NYSE:AXP), also known as Amex, stands out in third place, offering a unique investment appeal thanks to its distinct business model and premium customer base, setting it apart from its larger rivals.
Over the past twelve months, Amex has achieved approximately 80% gains, and if we look back further, it has seen nearly a 140% increase over the last five years.
In this article, I will highlight the key differences that set American Express apart from Visa and Mastercard, as well as other major credit card and payment network players. I will also explain why Amex remains an excellent investment option, even after its recent share price surge.
How American Express Outshines Visa and Mastercard in the Premium Market
One of the key points that sets American Express apart from its peers is its dual role as both a credit card issuer and a payments network. This unique position allows Amex to directly benefit from rising interest income on outstanding balances, meaning its revenues are closely tied to interest and fees. In contrast, Visa and Mastercard derive a larger portion of their revenues from transaction volumes.
Additionally, American Express has a robust business model that its peers lack. This model includes several important aspects: (1) an attractive and global premium customer base, (2) diversified and subscription-like revenue, (3) superior credit quality and performance, and (4) enhanced loyalty and engagement with its global brand.
To delve deeper into these outcomes and clarify what American Express offers, it is essential to note that its primary focus is providing premium credit cards. For instance, the Amex Platinum Card carries an annual fee of nearly $700. Consequently, its user base has a significantly higher income than the average of its peers, establishing American Express as a leader in the global premium customer segment. This is advantageous because Amex cardholders, on average, possess substantial spending power, resulting in three times the U.S. spend per card compared to other networks.
One of the most compelling aspects of the American Express business model, which provides a significant competitive advantage, is its diversified and subscription-like membership fees. This creates a rare case of recurring revenue outside the tech sector, akin to other highly successful companies like Costco (COST).
Not only does this membership fee model generate stable revenue, but it also grants American Express considerable pricing power. Over the past year, the annual fee for the U.S. consumer Platinum Card increased by 26%, rising from $695 in 2021 to 2023. Similarly, the annual fee for the U.S. consumer Gold Card surged by 28% from 2018 to 2023, now costing $250 a year.
Source: American Express' Investor Relations
Another noteworthy aspect of American Express is its superior credit quality and performance, bolstered by its diversified revenue model. The company maintains some of the highest standards in the industry, with approximately 23% of its revenue linked to credit quality. This means a smaller portion of its total revenue depends on how well customers manage their credit.
Source: American Express' Investor Relations
Unlike its peers, where a significant majority of income (about 85%) comes from net interest income, American Express generates around 78% of its revenue from spend and fees. This revenue includes merchant discount fees and annual card fees, resulting in American Express having five times higher average annual subscription-like card fees compared to its peers.
Source: American Express' Investor Relations
How is this possible? Thanks to its premium and loyal user base. In 2023, American Express boasted a remarkable business retention rate of 98%. Their users typically spend three times more than those using Discover, Visa, or Mastercard. This predictability in subscription revenue allows for easier price increases over time, further enhancing Amex's income.
Source: American Express' Investor Relations
A Closer Look at American Express's Financials
When examining American Express from a balance sheet perspective, several key points stand out. First, the company boasts a very high return on equity (ROE) of 32%, with an average of 31% over the past five years. This strong ROE also underscores Amex's ability to sustain profitability while maintaining a relatively conservative leverage profile compared to peers.
Additionally, we see a significant reduction in the net debt-to-equity ratio over the past decade, decreasing from over 3x to 1.7x in the last five years. This positive trend is also evident in the debt-to-assets ratio, which sat at a healthy 18.9% as of the end of 2023. This indicates that total assets far exceed the company's total debt.
Source: YCharts
Looking at earnings per share (EPS), we observe some fluctuations. There were down years in 2017 and 2020, but overall, EPS has experienced substantial growth over the past decade, rising from $4.91 to $12.81.
Source: YCharts
One area where American Express does not perform as strongly as Visa and Mastercard is in return on invested capital (ROIC). While their ROIC has consistently been above 10% over the past three yearsmeeting a typical benchmarkit is lower than that of their peers. Specifically, it was approximately 12.8% in 2021, 14% in 2022, around 11% in 2023, and currently is sitting at 12.6%.
Cash Flow Fuel for Growth and Dividends
As a credit card issuer with recurring membership fees, American Express generates strong cash flow, allowing it to utilize its free cash flow in several ways. Amex can reinvest in the business, pursue mergers and acquisitions, pay down debt, and buy back shares or distribute dividends.
American Express offers a dividend yield slightly higher than Visa's at 1.13%. The company has enjoyed double-digit dividend growth over the past five and ten years, indicating a commitment to increasing payouts. What I particularly appreciate is Amex's very low free cash flow payout ratio, even lower than Visa's, sitting at about 10.5%. This implies that Amex retains approximately 90% of its free cash flow for reinvestment and share buybacks.
Source: GuruFocus
In terms of share repurchases, Amex has been quite aggressive over the past decade, reducing its shares outstanding from about 1.08 billion to around 735 million by the end of 2023. This means Amex has bought back over 25% of its outstanding shares in the last ten years, which will significantly enhance shareholder returns.
Is American Express Worth Its Current Valuation?
After examining the competitive advantages and strong financial metrics in favor of American Express, the final question is whether this stock, priced at around $248, is a good addition to your portfolio. First, it's important to note that Amex has a beta of 1.21, indicating it is more volatile than the market. As a result, investors who are averse to short-term fluctuations may find the stock's price movements uncomfortable.
When comparing the valuation multiples of American Express to those of Visa and Mastercard, the stock trades at a forward P/E of 20.3x, which offers a significant discount relative to Visa's 28x and Mastercard's 34.6x.
Source: data from Seeking Alpha
For a more relevant comparison, if we look at peers like Capital One (NYSE:COF) and Discover Financial Services (NYSE:DFS), which also serve as both card issuers and payment networks, they have forward P/Es of 11.4x and 10.5x, respectivelynearly half of American Express's multiple. However, both Capital One and Discover focus on mass-market consumers and small to medium-sized businesses, targeting a middle-income segment. Thus, American Express's premium valuation is justified by its competitive advantage stemming from its high-income user base.
Final Remarks
American Express has carved out a unique niche in the credit card market by targeting high-income consumers, who are generally less affected by macroeconomic downturns. This strategy helps explain the surge in Amex's share price over the past year. The company even raised its EPS guidance last quarter to $13.30-$13.80, up from the previous range of $12.65-$13.15. If it hits the upper end of this range, it would represent more than a 17% year-over-year increase, outpacing Visa and Mastercard, which are expected to grow EPS by 13% and 16.4%, respectively, in 2024.
Moreover, Amex's strong credit quality and highly loyal customer base should translate into long-term value creation for shareholders, through dividends and buybacks. While the recent rally has made the stock less of a bargain than it was a few months ago, I still see American Express trading at a discount to Visa and Mastercard, and at a justified premium to competitors like Capital One and Discover.
With the credit card industry projected to grow at a healthy pace global credit card payment market size are expected to increase by 8.5% annuallythere seems to be room for further gains for American Express. Its business model, which focuses on high-income consumers and recurring revenues from membership fees, positions the company for continued success.
This article first appeared on GuruFocus.