American Express Earnings Momentum Won't Impress Investors. Here's Why

During the past five years, Visa (NYSE:V) and Mastercard (NYSE:MA) delivered more than 150% in total returns to investors, AmEx, at 80%, didn't even come close. In the past one year, the situation is even more dire: both Visa and Mastercard performed much better than American Express, in an environment when fears of a prolonged downturn and an economic slowdown hurt financial stocks. Among the three, only American Express showed a negative on its 1-year total return, -0.93%.

What makes AmEx a low-return investment when compared to its high-flying competitors is the credit issuer’s rigid business model which doesn’t help it when consumers decide to go on a spending binge. For example, most credit card lenders offer generous benefits to customers as a way of keeping them loyal as they spend, because the outstanding customer debt makes money for the company over the long run via high interest rates. AmEx’s high-end cards, on the other hand, generally don’t carry balances month-to-month, depriving the company of this lucrative source of income.

According to Credit Suisse, American Express's cost per dollar spent on rewards for its cardholders came to just 0.81% in 2017, compared to 1.1% for Capital One (NYSE:COF) and 1.24% for Discover (NYSE:DFS). This makes products with incentives—such as cash backs and points for a variety of awards—offered by competitors much more attractive, despite AmEx’s strong brand and the “experiential value” of its cards.

Another disadvantage we see that continues to drive the underperformance of American Express's stock: the company is more exposed to credit risk than its peers, Visa and Mastercard.

AmEx does not only act as the payment highway for funds, it is also the lender to its cardholders. This means that during an economic downturn, when consumers lose jobs and cannot pay their bills, Amex could see its bad loans rising at a much faster rate. Total provisions for credit losses rose 36% in 2017, and the company said it expects similar growth this year.

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Another major challenge for AmEx: to grow its portfolio in an environment where competition from larger banks is intensifying since credit card issuers make some of their richer returns from credit card portfolios when interest rates are low but they are able to charge high rates on outstanding debt to customers.

From its most recent quarterly earnings report, released in mid-October, it seems AmEx is doing just fine versus this competitive assault from such big bank rivals as JPMorgan Chase (NYSE:JPM) and Citigroup (NYSE:C). After raising its full-year guidance, American Express now expects annual revenue to increase 9% to 10% and adjusted profit to reach $7.30 to $7.40 a share in 2018.

For today's Q4 earnings report, scheduled after the market close, analysts expect $1.8 a share profit, up from $1.58 a share a year ago. Sales are expected to grow 20% to $10.56 billion.

Bottom Line

We don’t think these double-digit top and bottom line gains make AmEx shares an attractive alternative to Visa and Mastercard, our two favorite credit card stocks for long-term investors. In our view, American Express's stock, which closed yesterday at $99.41, will continue to lag, especially when the competitive pressures in the U.S. consumer market are intensifying.

In order to impress investors, AmEx will need to spend more on technologies and acquisitions, something that may already have begun to happen. On Tuesday, the company announced it had acquired Pocket Concierge, a high-end restaurant reservation platform in Japan. This move will give its cardholders enhanced access to top tier eateries there. As well, in December one of the company's executives revealed that AmEx had successfully conducted pilot tests with cryptocurrency XRP to facilitate real-time, cross border corporate payments.

In our view, that appears to be the only solid way to truly unlock American Express's brand value and increase shareholder returns.