American Express

This American credit card issuer and payment network is an excellent company with high growth rates,high revenues and an impressive brand value ensuring that customers are happy and stick around while spending significantly more than the average consumer. The fee itself, charged as the card is used, remains the engine driving earnings for a company that is back in shape after a minor, temporary setback.

The American Express payment cards are some of the most prestigious on the market, and for decades there have been rumours and talk surrounding just how exclusive they are. For example, people have speculated about spending requirements and high fees in order to have the privilege of owning, for example, the black Centurion card.

The most frequently issued American Express card is the so-called platinum card, and it is showing significant growth rates – in particular among the young and wealthy customers. That is in spite of growing competition and increased attention from the large banks such as J.P. Morgan and Citigroup. It is no coincidence that the banks are focusing more on growing this part of their business. Compared to other kinds of banking activities, the earnings potential and return on capital is higher in this business compared to traditional banking activities. While American Express manages to get a return on equity of approximate 30 percent, this number is merely slightly above 10 percent for the abovementioned large banks. This is an indication of significantly higher quality and value creation.

The exclusive American Express payment cards date all the way back to 1966, where the first gold card was issued. The previously mentioned platinum card was first issued in 1984. The fact that these cards are more exclusive than others is demonstrated by the annual card fee. While a platinum card costs around 1,500 dollars a year, the large banks charge a mere third of this amount for their “comparable” premium cards. 12 million new American Express cards were issued in 2018, and there are more than 114 million cards issued.

The higher card fees were not only a result of management’s ideas and contemplations. Right before the end of the 20th century, American Express issued the so-called Centurion card. This card was created based on rumours and myths about a highly exclusive “Black Card” reserved for the super-rich, where one thus had to pay sky-high fees and maintain high levels of spending. American Express took advantage of this when they launched Centurion. They still have not made the formal requirements public, but there are indications that the spending requirements amount to more than 250.000 dollars per year and that the annual card fees are some 2,500 dollars in addition to there being a significant startup fee. As co-owners, we think that it is fantastic to witness how the company can make money on the stories and fantasies of others.

The reason for the attractiveness of American Express’s business and for stores and companies around the world being eager to accept the cards is, among other things, that the card holders are in general spending more per card and, at the same time, they have higher than average credit scores. This provides American Express with a great deal of confidence that outstanding credit will be paid back and therefore reduces the required reserves – which is a positive factor in the previously mentioned high return on equity. The spending per card is about three times as high as for those using Visa and Mastercard.

 Loyalty clubs are gaining in popularity

Due to the above, there is a high brand value in an American Express card. For the cardholder, the card is a clear signal of wealth to businesses and society. This brand value is one of the reasons why American Express can have a higher fee per transaction – even if this is now under a bit of pressure from increased competition.

The number of cards continue to grow at decent levels, and the growth is particularly seen among cardholders between the age of 20 and 34, the so-called millennials, where the market share is currently smaller than in higher age groups. The growing market share in the young segment is a positive trend in terms of maintaining the long-term value-creation, as it is more profitable to retain a customer than having to invest in attracting a new one. Among other things, market shares are gained by maintaining significant investments in marketing with a focus on optimising how these investments are allocated – including the share being allocated to online marketing.

Having high-end payment cards is not the entire business, however. It is also accretive for American Express if they can increase the volume of payments on their payment network, and thus it also pays off to win market shares via other means as long as it does not negatively impact its brand and the image that has been created. In this context, American Express has developed a significant and continually growing co-brand business. An example of this is the issuance of new cards to loyalty schemes for the Hilton hotel network, and in 2017, the company also managed to retain the more affluent segment of the Marriott loyalty scheme after Marriott’s acquisition of Starwood. American Express had previously also been collaborating with Starwood. The large bank, J.P. Morgan, won the remaining scheme in which the members of the customer club used payment cards from Visa, which is – by the way – also one of our companies.

Not all stores accept American Express cards, and fortunately, management has increased focus on this. Their goal is for the cards in the United States to be accepted in as many places as for the more widespread cards from Visa and Mastercard. In the United States, the number of stores that accept American
Express cards grew by a million in 2018, and there was also a double-digit growth rate internationally. This adds another layer to the growth-potential. At the same time, the migration from cash to cards or digital payments results in favourable secular tail wind driving revenue and earnings growth.

American Express was hit by a short-term setback in 2016, when the retail chain Costco terminated its collaboration with American Express and thus terminated around 10 percent of the issued cards as a result of this. Since then, however, there has been significant growth in the company. The growth in revenue and earnings has even accelerated throughout 2018, leading to the company having to increase the expectations for the year. The expectation for revenue growth went from 7 to 8 percent at the beginning of the year to almost 10 percent. This was driven by both strong growth in the American cardholder segment and growing success in the international part of the business.

Mastercard and Visa, who we also co-own and thus write about in this book, also process payments on their networks but are solely focused on the technology. American Express is involved in a large share of the value chain as they are running a so-called ‘closed-loop network’. Besides processing interbank transactions, American Express also issues cards and is more involved in the communication between the point of payment and the banks. It goes without saying that this is a bit more of a comprehensive affair, but at the same time it allows for greater access to the data of the cardholders – and American Express can securely and legally use this to help the business owners who are part of its network. In addition, it means that American Express also holds deposits for cardholders and has a credit risk on the credit cards.

 Renewed energy in the management team with a new CEO

The American Express model is to a much higher extent driven by spending on the cards than is the case for banks issuing credit cards. Every time a transaction is made with an American Express card, American Express charges a fee of approximately 2.4 dollars for every 100 dollars of the transaction. The increased
competition, in addition to decent growth in previously mentioned co-brand cards,
has resulted in a larger proportion of so-called rewards being provided. Rewards are customer points granted based on spending that the cardholders can then use to buy services among American Express’s network, such as hotel reservations, travels etc. Spending-related fees contribute to more than 70 percent of revenue in American Express.

American Express is in a strong position when it comes to issuing corporate cards. Here they have a leading position in part due to solutions that are integrated with the customers’ accounting software. This integration makes it easier to keep track of the customers’ travel accounts and receipts. Today, American Express is the favoured partner of large companies, but there is also a strong focus on gaining market shares among small and medium-sized companies where growth is currently higher. The objective is to increase the number of cards and spending that can create value by running through the network.

The CEO is Stephen Squeri, who assumed this prestigious post in 2018. However, he is not new to American Express. He joined the company in 1985 and was Vice Chairman of the board for three years before his promotion to CEO. The previous CEO, Kenneth Chenault, had charted a sound course for American Express for over 16 years, but we look forward to an addition of new energy in the management team while at the same time we are pleased that the strategy and culture will have some continuity. This is one of the strengths of well-managed succession planning and of retaining highly capable employees.

Previously, the company’s financial target was to grow earnings per share by between 12 to 15 percent per year. Today this objective is a bit lower but still at a very decent level of “above 10 percent”, and this is to be achieved on the basis of 6 percent growth in revenue, combined with strong management of costs and an ongoing share buyback programme. Due to the capital efficiency of the business, American Express has historically been able to distribute the entire annual earnings to shareholders via dividends and share buybacks. The tax reform in the United States in December 2017 resulted in a re-valuation of deferred tax assets, and as a result, the share buyback programme was suspended in early 2018 to restore regulatory capital. However, since the summer of 2018 the company has resumed buying back shares which we find value-creating, and this is in addition to an annual dividend of 1.6 dollars per share, which amounts to more than 1.5 percent of the market value. In 2017, which was the last full year with share buybacks, the company returned more than 6 percent of the market value to the owners.

Improved credit scores among customers

American Express has for many decades been a unique player on the credit card market for the wealthy, and despite increasing competition, we still view them as having a unique competitive advantage with the brand and image of being the card of choice for the affluent and large spenders – a reputation that cannot be diminished or recreated over a short period of time.

The credit scores of the cardholders can, for example, be measured by the annual credit write-downs only amounting to approximately 1.5 percent of the total outstanding loans. This is half of what is seen among the primary competing credit card issuers. The cardholders have good credit scores, and those scores have improved since the financial crisis. There are thus seven times more cardholders who have a “very good” FICO score than those having a score assessed as “low”. Lending to the right consumers can be value creating, and we are therefore glad to see that part of management’s strategy involves increasing the share of credit of cardholders – this also benefits the shareholders.

In 2018, lending increased by more than 30 percent, and we see no indications that credit quality is decreasing. The net interest income amounts to approximately 20 percent of revenue, and this is significantly lower than for many other credit card issuers. The net interest margins in American Express are more than 10 percent, which is very high.

A higher amount of spending on the card, whether this is the platinum card or the mythical Centurion card, is the best path to higher earnings and valuecreation. Considering the company’s high-spending and credit-worthy cardholders, we as shareholders can look forward to even more value – and all of this at a price of less than 12 times the current year’s earnings. We see this as a good investment.