American Express – A Single Digit Stock?

Despite the horrendous 72% sell off in American Express this year, I would still not be a buyer at the recent price of $19 for the following reasons.

From my personal experience in the mortgage business, I have seen many people turn to their credit cards once the home equity cash out loans were no longer available to them.  The credit cards were used to maintain a now unsustainable life style or to bridge the gap between income and living expenses.  Now that credit card lines are being reduced or simply maxed out, the last option for many people is now closed.  Since AXP gets around half of their revenue from the fee charged to merchants when a credit card is used, this income is obviously going to see a reduction.

Moody’s recently cut AXP’s investment grade by one notch to A2 (still very respectable) but the trend is clear.  Moody’s is expecting the recent earnings decline at AXP to continue, especially in view of the broad economic weakness and overleveraged consumer.

The fact that AXP decided to request $3.5 billion in capital from the Treasury’s TARP fund also raises many red flags – if AXP wasn’t expecting further problems in its basic business they would not be requesting theses funds.  In any event, AXP needs to refinance approximately $24 billion of debt over the next year; if the credit card securitization window remains closed, AXP may be back in line very soon for another TARP injection.

AXP expanded its business during the peak of the credit boom, expanding their credit card loans by some $26 billion over the past 4 years – an increase of 68%.  Timing is everything and they definitely got this one wrong, possibly by assuming that an overextended credit card customer would simply pay off his unmanageable credit card debt with his next cash out mortgage refinance.  Unfortunately for AXP, the days of constantly borrowing more money to pay off past borrowings has come to a halt.

Also, extremely unfortunate for AXP is the consumer attitude that debt that cannot be easily paid off should be easily forgiven, either by the company that lent the money or the bankruptcy courts.  If AXP needs proof of this, they can check out the Bank of America, Citibank, JP Morgan etc loan modification programs for mortgages.  At a time when collarteralized debt is being forgiven, unsecured credit card debt will be easily walked away from as well, as evidenced by the 100,000 plus (and increasing) personal bankruptcy filings each month.  Overleveraged consumers forced to borrow for years to bridge the gap between incomes and expenses will no doubt have no trouble being approved for a Chapter 7 debt liquidation instead of the Chapter 13 payment workout resulting in zero recoveries for AXP on outstanding credit card debt.

If you apply conventional, historical valuation metrics to American Express, the stock looks ridiculously cheap.   Unfortunately, I don’t thinkthe present economic disaster is going to end anytime soon and if that is the case, AXP will be facing a bleak future not only in its future earnings but also in its ability to refinance their 6/1 leveraged balance sheet.

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