Security: NYSE:AXP
Date of first purchase: February 24, 2009
I am buying shares of the American Express Company at $12.27 per share (including commission) because I believe the business is actually worth $28 to $33 per share. This implies that at American Express’s current market capitalization of $14Bn, it is being priced at a 57% to 64% discount to its true value of $33Bn to $39Bn. This margin of safety should allow generous room for error or misfortune if in the long-run my determination of the true value of ownership proves to be incorrect.
Large and rapid layoffs have transformed the credit crises of 2008 from a concern over the liquidity and solvency of corporations to a concern over the debt holdings of consumers and small businesses. Payment companies like American Express have been forced to write-off larger numbers of past due loans, increase loan-loss reserves, and restructure as consumers and businesses worldwide reduce expenses. With no certainty as to what percentage of cardholders will default on their obligations, equity investors in these companies have taken a “sell now, think later” approach to valuation. I don’t blame them. Given the dour headlines flooding the news media, those worried about the near-term liquidity and profitability of payment companies are justified in their pessimism. American Express will most likely have annual income well below its 15-year trailing average over the next few years.
However, in the midst of non-stop dire forecasts regarding consumer spending and defaults, the strengths of the company’s brand, costumer base, and management are being ignored. Unlike its larger competitors (Visa and MasterCard), American Express seeks and serves more affluent customers. It attracts its clientele not through the aggressive lending promotions that the issuing banks of its competitors have long-offered, but through an impressive, long-built reputation. This reputation draws merchants eager to sell to American Express’s higher-spending cardmembers and attracts members eager to reap the rewards of the company’s incomparable loyalty programs. Nowhere is this more evident than in the fact that even after three years of aggressively (too aggressively) increasing its lending, American Express still derives the vast majority of its revenue from membership fees, travel commissions, and the fees it charges merchants for transactions—not from the revolving balances of its cardmembers. The management of American Express has long been more comfortable competing on branding initiatives, merchant relationships, and customer service than on interest rate spreads.
This is not to say that the company benefits from the credit contraction and economic downturn. American Express derives 70% of its revenues from the United States. A consumption-led recession in the American economy will surely hurt the company’s near term earnings. In comparison to the earnings of recent years, forward earnings will pale in comparison. But if the company’s average earnings over the past 15 years provide any index as to what the company may again earn in more normal business conditions, then American Express is poised to return to a market valuation more appropriate to its long-term results. And though there will be government initiatives (some commendable) to reduce consumption as a share of U.S. GDP, consumer and business spending will return to levels that make American Express not only a profitable business but also a stellar one. For these reasons, I am making an investment in American Express with the expectation of protecting principal and achieving a moderate return.
Additional Purchase: March 10, 2009
I bought additional shares of American Express today at $12.05 per share. This purchase increases my total ownership stake in the company, and slightly reduces the average cost of my shares to $12.13 from $12.27 (including commission).