American Express (AXP) stock is 20% off its annual high, a reflection of the concern and focus that shareholders have given to the company after Costco (COST) dropped it as the only credit card accepted at its warehouses.
That was a big blow to American Express after a 16-year partnership, as Costco accounted for 8% of all spending on American Express cards.
While investors were clearly defeated by this news, American Express is now a great long-term investment opportunity, as AXP pushes forward to strike new deals and pursue new opportunities.
What Makes AmEx so Great?
First and foremost, American Express is not like other credit card companies that earn the bulk of their income via interest. American Express earns its income from annual membership fees and transaction fees.
American Express is a company built around exclusivity, with the company claiming that its cardholders’s average income is 60% higher than non-AmEx cardholders. Further, American Express claims that its customers charge over half of their personal spending to their AmEx, whereas non-AmEx customers charge about one-third of their personal spending. In other words, AmEx customers make and spend more money.
That’s why AmEx can charge merchants a reported 50% more than non-AmEx cards for transaction fees, and that is also why growing customers and merchants is so important to AmEx’s business. It is exclusivity, high spending and high income that gives AXP so much leverage with merchants.
Replacing Costco Can Be Done
With that said, Costco realized that dealing with American Express had its perks, like a wealthier clientele and more spending, but got tired of paying those higher fees. But keep in mind, Costco was just 8% of total transactions, a number that American Express can replace with enough new customers and partnerships.
Earlier this year, American Express added Sam’s Club to the list of retailers that accept AmEx cards. Sam’s Club earned nearly $60 billion in revenue last year, which are potential transaction fees that American Express had no chance to earn in the past.
On top of that, American Express partnered with Charles Schwab (SCHW) back in March. This is a big win for AmEx, as its customers and those of Charles Schwab would appear to be aligned, as Schwab’s customers are typically middle-aged folks with savings and retirement accounts.
Lastly, American Express joined forces with Well Fargo (WFC) in 2013 to launch two new credit card products. This opens AmEx up to Wells Fargo’s 70 million banking customers, 50 million of which don’t own a bank-issued credit card. So collectively, American Express’s partnerships with Wells, Schwab and Sam’s Club may not replace Costco, but it does move the company in the right direction, and suggests that the 20% valuation loss in response to losing Costco as a customer is unwarranted.
AXP Looks Ahead to Its Future
American Express’s stock loss looks even worse when you consider that Visa (V) and Mastercard (MA) stocks have increased 6% and 5%, respectively, this year. So clearly, the weight of losing Costco has been excessive, with the stock showing no regard for these other wins or the moves that AXP is making to solidify its future.
This includes the move to prepaid cards, something that I believe could prove to be a major long-term catalyst. In the past, American Express has selected customers based on their credit profile and income, but those who qualify are mostly over the age of 35. By entering the prepaid space, American Express can develop a relationship with customers who might not otherwise qualify for its credit cards, but may in the future.
Also, the prepaid card business is growing fast. The financial-technology consultant, Aité Group, estimates there were $200 billion worth of purchases with prepaid cards in the U.S. last year. That number is expected to increase upward of $420 billion by 2017. While small relative to the $1 trillion that American Express billed last year, it’s still a sizable market that American Express can penetrate and ultimately translate to AmEx credit card customers.
All things considered, AXP has a lot going in its favor, most of which is not realized by the investor public due to the emphasis on Costco. While I agree that losing Costco was bad, American Express’s business has recovered nicely, and so will AXP stock.
As of this writing, Brian Nichols did not hold a position in any of the aforementioned securities.
