American Express (NYSE:AXP) is hardly firing on all cylinders, but its stock sure is.
Too bad the easy money looks to have already been made.
AmEx has already been rallying hard in 2013 and gave shareholders more to cheer about Wednesday after the company lifted its dividend to 23 cents a quarter from 20 cents, making the forward yield 1.35% vs. 1.17% previously.
Since the start of January, the stock has gained 19% for the year-to-date, beating the Financial SPDR (NYSE:XLF) by 6 percentage points and the S&P 500 by 8 percentage points. It’s also clobbering its closest peers: Discover Financial Services (NYSE:DFS), which is up about 14%, and Capital One Financial (NYSE:COF), which is off about 1% so far in 2013.
Anytime a stock runs up so far, so fast, you have to worry whether it’s gotten ahead of itself. (You also need to be concerned that if we do get the annual spring selloff — also known as “Sell in May and Go Away” — AmEx will have that much farther to fall.)
Operationally, AmEx does indeed have a lot going for it. It’s beaten Wall Street’s earnings expectations every quarter for a couple of years now. Its customers are bigger spenders — corporate cards and the relatively affluent — so it’s able to get away with charging much bigger transaction fees to merchants. AmEx takes an average commission of 2.6%, while the broader industry gets 1.6%.
Also, unlike payments processors, AmEx has a closed-loop network, where it acts as the issuing bank, the network provider and the acquiring bank. That means it gets to keep the entire transaction fee — as well as all the customer spending data.
In another advantage, the average AmEx household has annual income of $97,000 a year — roughly twice the national average. That “premium” position leaves the company less exposed to the risk that cardholders will miss payments. That helps explain why AmEx has the lowest rate of delinquency among all the big credit card issuers.
But that doesn’t mean business has been good enough to support what looks like an unsustainably pricey stock.
AmEx has been beating Street profit estimates but, as was the case in the most recent quarter, it’s more thanks to cost controls than robust revenue growth. Like so many other companies this earnings season, AmEx’s revenue fell short of analysts’ expectations. More worrisome is that it has now missed top-line forecasts in three of the last four quarters.
True, global cardholder spending (billed business) rose 6% year-over-year, which isn’t bad considering the tepid business climate and rash of corporate belt-tightening. But that single-digit percent growth confirms a year-long sluggish trend. AmEx hasn’t seen global cardholder spending hit double-digit percent gains for four consecutive quarters. Yes, it’s growing, but not that fast — and at about half the rate it was two years ago.
Partly that’s because corporate spending and international travel commissions are easing — something which doesn’t bode all that well for business spending going forward. Although trends remain stable, they don’t look set to accelerate, either. And corporate customers account for more than a quarter of AmEx’s U.S. billings.
Besides, as much as AmEx made headlines with its seemingly downmarket move to sell prepaid cards through Walmart (NYSE:WMT), that’s a small slice of its pie. Sure, the company gets deposits and transaction fees from those AmEx Bluebird cardholders, but there’s fewer than 600,000 of them. At the end of the most recent quarter, AmEx had more than 100 million active cards out there.
AmEx’s stable but sluggish spending growth — amid a tepid U.S. expansion and recessionary conditions in Europe — makes the stock’s valuation appear a bit overheated at current levels.
The stock has run up so much that its forward price-to-earnings (P/E) ratio has blown past peers. AmEx sports a forward P/E of more than 13. It’s closest rivals — DFS and COF — trade for about at most 9 times forward earnings.
It’s also problematic that AmEx has now breached Wall Street’s average price target of $68 a share. When a stock hits an analyst’s target, there are two things the analyst can do: Raise the target or downgrade the stock. With AmEx hitting new all-time highs, we can expect downgrades on valuation any day now.
It’s not that business is bad; it’s just not good enough to justify initiating a position in AmEx when it’s setting record highs. Better to wait for a significant pullback — or find more attractive risk-reward scenarios.
As of this writing, Dan Burrows did not hold positions in any of the aforementioned securities.