American Express: The Bargain Is Over, Now It’s A Hold (NYSE:AXP)

Introduction

Around the end of summer, I wrote my first article on Seeking Alpha, which was about American Express (NYSE:AXP) (I recommend you take a look here). At that time, Amex’s stock was trading around $160, and I outlined a number of reasons why I believed the business would perform well over the long term. Although it is clearly too early to judge whether my long-term predictions are being met, I believe we can see that progress is being made towards meeting them.

Today, American Express’s stock has experienced a very strong rally since the October lows. I believe that this aggressive rally has simply been an adjustment between the stock price and the real value of the business. I do not believe that the stock is overvalued today, but it is certainly not the bargain it was at $140. In this article, I want to review the business performance over the past few quarters and make projections for the next year. More importantly, I want to review whether the long-term outlook is still as positive from my point of view.

Investment thesis

If you remember, in my first article I commented that my thesis, according to which American Express was going to outperform the market in the next decade, was based on three main points. First, their strategy to attract Generation-Z customers and how profitable this was going to be in the long term. On the other hand, their focus on top-tier customers with higher purchasing power protected them both from the risk of delinquency and defaults, as well as safeguarding future cash flows by relying on an audience with greater savings, spending, and financial education. Lastly, the significant deleveraging process the company has experienced over the last decade was expected to enable greater generosity with share buybacks and dividend increases. So let’s see how these three aspects have been developing in the company over these months and if we were pointing in the right direction with our thesis.

Gen Z clients

This perhaps is the most challenging point to track as it is a long-term strategy. However, if we pay attention to the CFO’s words during the earnings call, it seems that they remain very committed to the strategy and are executing it correctly. Therefore, as long as progress continues in this direction, I believe we can be content as shareholders since this strategy is designed to protect the terminal value of the business in the long term, and gradually we will see the fruits of it.

“With the growth in new accounts we’ve seen over the past few years, we now have a total of over 140 million cards running on our global network. Our focus on continuously innovating our value propositions to meet the needs of our customers is driving increased brand relevance across generations, including millennial and Gen Z consumers. These customers represent over 60% of the new consumer accounts we acquired globally in 2023, and 75% of new consumer Platinum and Gold accounts acquired in the U.S. came from this cohort.” (…) “We continue to see growth across all generations and age cohorts with millennials and Gen Z customers again driving our highest billed business growth within this segment. Their spending was up 15% this quarter.” – Christophe Le Caillec (American Express CFO).

Top-tier clients

As we have already discussed, the second pillar supporting my long-term thesis on American Express is its focus on the wealthiest clients in society. This is crucial in the banking sector as it greatly reduces the risk of default and delinquency. In this regard, we see how in 2023 the delinquency metrics remain at very healthy and manageable levels for the company. Witnessing these numbers grow rapidly could indicate that we are on the brink of macroeconomic problems, or worse yet, that American Express is allowing lower-quality clients into its ecosystem. The latter would be a red flag from my perspective as it would completely undermine American Express’s differentiating value compared to other North American banking institutions. If you want to review the delinquency rates of the major banks in the US yourself, I recommend taking a look at this Seeking Alpha news article.

Also related to this, last quarter I came across a very interesting topic, which is the CEO’s vision regarding a possible alliance with other financial institutions, presumably Apple, with which they have already been linked several times recently. In the following statements, the journalist asks the following:

There were several articles that cited you as a potential candidate to take over a card partnership from another large financial institution, I’m not going to name one that is. But I guess maybe just talk about your interest in adding co-branded partnerships? – Ryan Nash (Journalist)

To which the CEO responds as follows:

Well, I mean, you look at it and you say, is your premium card base one of the biggest impediments you would have because sometimes the partner wants to reach everybody? And that’s not who we are, right? When you think of American Express, you’re thinking of the top end of the premium space. And we’ve been able to make that work with Delta, with Hilton, with Marriott, with British Airways and a lot of others. And so there are others that we haven’t worked with or haven’t engaged with because of the breadth of the card base, the breadth of their customer base, and that’s how we think about it. – Stephen Squeri (CEO)

In these statements, it is made clear that the CEO’s vision for American Express is that not everyone can access their products. When you think of American Express, you think of the most premium segment of society, and that’s where they want to focus. Let’s put this into context: the CEO of American Express is openly stating that the customers that an alliance with Apple (or other financial institutions) would bring them are not premium enough for them. They are presumably rejecting an alliance with the world’s largest company, at least by accepting all of its customers.

For some, this may be seen as a mistake since the growth potential would be enormous, but the goal is not just to grow for the sake of growth. The most important thing is to preserve the terminal value of American Express, and the best way to do that is to continue focusing on the most premium segment of society. Accepting any customer would result in lower-quality clients entering the ecosystem and would lead to increased delinquency ratios, as well as eroding the brand image of Amex by diluting its exclusivity. I love seeing CEOs who have such a clear vision for the company and who are focused on preserving the company for as long as possible, even if it means sacrificing short-term growth.

Deleveraging

Finally, in my previous article, we talked about the enormous deleveraging that the company had experienced in the last decade and that this would bring significant increases in dividends and more aggressive share buyback programs thanks to its improved financial position. In this sense, it seems that this is being fulfilled. First, in the latest earnings presentation, they announced that they would increase the dividend by an incredible 17% in 2024, from $0.60 quarterly to $0.70. Even with this increase, the payout ratio will remain around 20%, which is well within a very sustainable range and can continue to grow in the future.

On the other hand, shares outstanding decreased by 2.15% in 2023, while a few quarters ago they approved a $15 billion buyback program. At current prices, when this program is completed, 10% of the shares outstanding will have been eliminated. I would not be surprised to see this pace of share reduction accelerate to even 3% per year due to the company’s healthy balance sheet and strong cash generation, as we will see now.

In the following chart, we can see how the capital returned to shareholders since the beginning of the pandemic has been very significant, with the dividend per share increasing by 43% (bearing in mind that it wasn’t increased in 2021) and having reduced the outstanding shares by more than 10%.

Obviously, if we delve deeper into why they have been able to return all this capital, we observe excellent management by the executives as well as fantastic business performance. Later, we will analyze the income statement as such, but for now, I want to focus on the balance sheet which clearly shows how this deleveraging I speak of is real and how American Express’s financial situation is much better now than a decade ago.

The balance sheet of American Express is not easy to interpret, as they explain in their 10K that they have different types of debt, with different ratings even, but I will briefly review the most interesting points. First, we see how cash and equivalents have surged by more than 25% this year, driven mainly by the increase in cash as well as deposits in other banking institutions. With the rise in interest rates, this increase in deposits is positive as they generate more interest with their cash than in previous years. Deposits from customers in American Express itself have also experienced a notable increase. This was something I also mentioned in my previous article. This is what we discussed then:

“Therefore, their utmost priority is to establish themselves as a trustworthy company with a positive image in North America. Following the banking panic that occurred with SVB, many individuals sought secure havens to safeguard their money.” – My last article about American Express

As we can see, deposits have increased by 15%, highlighting the trust that American Express generates, as we commented. Then, long-term debt also increases but clearly at a slower pace than cash, so practically American Express remains with a net cash position. This seemed impossible a decade ago when net debt reached nearly $40 billion. I reiterate that the company’s financial situation is infinitely better than a decade ago, and I think this point is key and will be the lever they use to outperform the market in the next decade, in addition to the organic growth of the business itself.

Valuation and conclusions

Having conducted a fundamental review of the company, it’s time to reassess its valuation to see if we might be facing a good buying opportunity despite the significant increase we’ve experienced in recent weeks.

For my valuation, I will assume that next year revenues will grow by 5% both in interest and non-interest income, and from there, non-interest income will grow by 8% annually while interest income remains stagnant. I prefer to assume that the latter will not grow because, given the highly probable interest rate cuts by the FED, it will be difficult for American Express to continue growing these revenues clearly. Thus, I prefer to be rather conservative and assume they will stagnate, although they may not.

I will also assume a slight margin expansion and, as discussed in the article, a 3% annual reduction in outstanding shares. Finally, I assign a multiple of 16x, in line with its historical average. Although this multiple may expand to around 18x due to significantly reduced terminal risk this decade through deleveraging, I prefer to remain conservative and keep it at 16x.

With all this, we arrive at a target price for 2028 of $328, which represents a compounded annual growth rate of 8.25% from current prices. If we add the dividend, which yields approximately 1.5%, we could be looking at a total return of around 10%.

From my point of view, a 10% annual compounded total return is insufficient to purchase this stock. In my opinion, I would prefer to have potential returns of 15% for a stock of this type, so I am downgrading the company’s rating from “Buy” to “Hold.” When we wrote the previous article, the company was clearly undervalued, and to me, it was a bargain. However, nowadays, it remains a reasonable investment, but I would like to have a higher expected return before buying it. As I always say, this doesn’t necessarily mean you should sell it if you already hold it in your portfolio. I don’t think it’s a good idea to sell a wonderful company like this solely because it might be slightly overpriced.