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American Express Shrugs Off Higher Expenses With Continued Growth

The wide-moat firm’s recent growth has been exceptionally diverse and widespread and we see shares as modestly undervalued.

Wide-moat

American Express' recent growth has been exceptionally diverse and widespread as the company’s two largest segments, global consumer and global commercial, increased revenue after provisions by 12% and 9%, respectively. During the earnings call, management mentioned that new consumer accounts on its U.S. Platinum Card are up more than 50% and half of that growth is attributable to millennials. We've been unsure if the company’s brand resonates with younger consumers and American Express' recent success modestly eases our concerns the company can generate growth from the next generation of consumer.

American Express' Competitive Advantages Remain Intact

The payment industry is changing as both merchants and issuers vie for control of rewards and loyalty. Over the past decade, merchants have won lower fees from payment processors, driving interchange fees down across the globe. Banks burned by losses produced by lending to subprime borrowers decided to target high-end customers and the fees they generate. We believe digital payments will increase the number of payment options available to customers, increasing competition for market share. Competitors seem willing to bid aggressively for business by offering ever-higher levels of rewards (as in the case of

That said, American Express' competitive advantages--a reputation for superior service, a network of attractive customers and merchants, and a corporate business with high switching costs--remain intact, and we think the closed-loop network's close ties to cardholders and merchants provide a solid base for the next phase in the company's history. We think there will be a huge opportunity to connect merchants with individual customers based on individual preferences and spending patterns, and that closed-loop networks provide the best opportunity to do this. American Express highlighted its efforts in this area at its 2018 investor day--it provided 15 million customers with information on local merchants in 2017. Industry experiments in this area are in the early stages, and we think successful efforts offer big growth opportunities. We like that American Express is accelerating its investments in this realm, and we think the company may be reinvigorated under a new CEO as the payment industry experienced the most significant changes in decades.

We also believe the company's corporate business is an underappreciated crown jewel. American Express is a dominant force in corporate spending and is leveraging its data into additional services for its business customers, from lending to expense management. Furthermore, the increasing sophistication of small business will provide a tailwind as these companies begin to utilize various services long used only by larger corporations.

American Express' wide moat is due to a combination of several factors. First, the company's brand is a powerful intangible asset. It has maintained superior customer service ratings for decades, and its direct relationships to merchants--and bargaining power--allow it to represent cardholder interests in disputes. Furthermore, its standing as a monoline prevents its brand from being tainted by missteps elsewhere--most of its competitors are the systemically important banks that have suffered from regular public stumbles over the past decade. This is arguably a disadvantage since it competes with more-complex institutions, but its lack of a legacy branch presence provides a cost advantage against these same competitors.

The company's corporate card business is another key source of advantage. The company handles corporate cards for a significant percentage of Fortune 500 companies. Tied closely to company's financial management systems, American Express' corporate business benefits from much higher switching costs than its consumer business. Its dominant ensures that merchants in the travel and entertainment industries--about a quarter of American Express' business--must accept both the brand and the higher rates it carries.

Increasingly, customer data will be an intangible asset. American Express' closed-loop network could conceivably allow it to monetize its customers' spending habits to provide differentiated rewards--meeting the needs of both merchants and cardholders.

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