1 Reason American Express Can Keep Winning

American Express (NYSE:AXP) has returned 19% year to date through the close on Mar. 26 — far outpacing the other major credit card companies. It’s also handily beating the S&P 500, which is up about 6%.

There are a few reasons why American Express has outperformed its peers this year — and one major reason why it will keep winning.

Not like other credit card companies

American Express is the third-largest credit card company, but its business model is different from the big two. Unlike Visa and Mastercard, American Express provides the loaned funds to its card users, and for most of its card varieties, requires full payment of the balance at the end of each month. In effect, it’s part bank. 

A man looking at his phone, happy about what he is reading.

Image source: Getty Images.

As the credit issuer, it brings in revenue from interest income, like a bank does, as well as from member fees and merchant transactions. Specifically, about 24% of its revenue comes from interest on loans, roughly 60% from swipe fees from merchants, and around 16% from cardholders’ annual fees.

American Express’ share price lagged its competitors in 2020, down about 1% for the year, in part because it had to set aside funds in credit loss provisions, which Visa and Mastercard did not have to do.

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In addition, lower consumer spending led to it earning less in swipe fees and interest income. All of this, of course, was due to the pandemic and the recession it triggered. And the biggest hit to American Express came from the virtual shutdown of travel, as a lot of its revenue derives from travel- and entertainment-related spending.

Discount revenue, or revenue from swipe fees, was down 22% year over year in 2020, while interest income declined 14%. Only card fee revenue increased — by 15%. Total revenue dropped 17% for the year.

But in the fourth quarter, its earnings improved because American Express didn’t need to make additional provisions for credit losses. In fact, AmEx had a $111 million provision benefit due to a reserve release of $674 million, thanks to an improving economic outlook and strong credit performance by the institution.

Delinquencies and write-offs were at the “lowest levels we’ve seen in a few years and are best-in-class,” said Chairman and CEO Steven Squeri during the fourth-quarter earnings call. He also said he expected the current reserve levels to be sufficient for 2021.

Growth in consumer spending is also helping the company. In January, consumer spending was up 3.4% over December, and while in February, it dropped by 1%, it was still above December’s level, according to the U.S. Bureau of Economic Analysis. The stimulus checks that are in the process of hitting Americans’ bank accounts will certainly boost those levels in the months to come. As the year goes on and more of the population gets vaccinated, consumer spending should jump even higher. Some economists predict record-breaking consumer spending increases in 2021.

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Get ready to go

Increased spending and improving credit quality are good things for American Express. Already, it saw a 4% increase in non-travel and entertainment spending year over year in the fourth quarter. But what will really propel the company’s rebound in the latter half of 2021 and into 2022 will be travel and entertainment spending. Just to get a sense of how big a hit American Express took in this area — in the fourth quarter, spending in the category among American Express users was down by 65%, and that was the best quarter of 2020.

By 2021’s fourth quarter, the company expects travel and entertainment spending to recover to 70% of Q4 2019’s level, and expects it will keep rising in 2022. Spending outside of that category has already recovered.

All of this should allow American Express to maintain its progress over the next few years. And given that the stock is trading at a relatively low valuation of 20 times earnings, investors could profit from that momentum.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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View more information: https://www.fool.com/investing/2021/03/29/1-reason-american-express-can-keep-winning/

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