American Express Stock Crashes After Weak Guidance

  • Price to Cash flow multiple is very cheap compared to US banks and the company through its investments is slowly building equity.
  • Guidance was taken as weak by the market and American Express stock sold off after earnings.
  • American Express is nicely hedged against a slow down in the US in that a slowdown should bring about dollar weakness which would help its international divisions.

American Express stock dropped further 3%+ to $60.35 a share in the aftermarket in New York on the 21st even though American Express (NYSE:AXP) reported an earnings beat on both its top and bottom lines. An EPS of $1.23 on sales of $8.39 billion were the reported numbers against expectations of $1.12 on $8.34 billion in revenue. 2016 guidance was what sank the American Express stock. Tthe forecast reported is between $5.40 and $5.70 a share in earnings.

Now earnings guidance is actually above what analysts have expected for 2016 but American Express's numbers include the Costco (NASDAQ:COST) portfolio sale (we do not know the sale price thus far). Therefore, when you subtract the impending Costco gain from the numbers, the real earnings guidance is between $4.70 to $5.00 in earnings per share which is a far cry from its 2014 earnings of $5.56 a share or even the year gone past which ended up at $5.05 a share.

The company also reported that it would undertake cost cutting measures (with an initial target of $1 billion in cuts by 2017) to address the situation but it still wasn't enough to stop the American Express stock from sliding. In an earlier article, I pointed out that I believed downside risk in the stock price was limited and I stand by this assertion.

Firstly even though you may see more downgrades from analysts in the weeks ahead, American Express's valuation metrics are getting pretty oversold at this point. I acknowledge that its price to earnings ratio is trading at similar levels to US banks but if we go deeper, we can see that its price to cash flow ratio is trading around 6 which is much cheaper than Wells Fargo (NYSE:WFC) for example, which presently has a price to cash flow multiple of 11.1 matching its earnings multiple.

Investors should remember that American Express spins off much higher free cash flow numbers (well over $9 billion a year) than net income, but unfortunately, many investors only look at the bottom lime for guidance. Why is cash flow important? Well, firstly American Express's payout ratio is only around 20% which means there is no risk to the dividend or future share buybacks and secondly there is ample cash to build the business going forward.

Strong operating cash flows are the basis for a low price to cash flow multiple. If you compare American Express's cash flow statement against the main US banks, you will see that its operating cash flows are consistent and stable which is what is required now for investing in the financial sector.

Apart from the extremely competitive market place at present, which is driving down margins, earnings are also going to be affected going forward by the company's elevated spending which is needed at present. After losing lucrative contracts such as Costco and Jetblue, the company needs to increase spend to gain back market share it had lost to the likes of Visa (NYSE:V) and Mastercard (NYSE:MA).

Furthermore, I expect discount rates to decline further this year due to sheer competition, regulation and pricing models on new cards. Nevertheless, what I would say is this. Most of the company's spending initiatives are front loaded meaning American Express is not going to see benefit immediately from its spending initiatives but I'm confident, good returns on investment will eventually come through, especially when you see the average return on equity percentages this company prints every year (27%+ per year).

Long term debt is still more than double the company's equity but equity is rising and through the credit card company's latest investments, this metric will continue to grow. Even if American Express can't match the previous return on equity levels (ugly 24% last quarter), net income should rise beyond 2016. It will take time for the company's investments to show a return, but investors should remember that building equity in a company like American Express yields 25% in ongoing annual earnings. Other banks in the US don't come close to this metric which demonstrates it's not about growth in assets but rather what the company in question can make of those assets.

Finally, with respect to the company's different divisions, its US card services saw its revenues rise by 5% due to higher fees, higher loans and average card spend being higher across the division. However the company's international divisions again had declines in their top lines (International card services, Global commercial services and Global network & merchant services) primarily due to US dollar strength.

These three divisions alone account for almost 40% of the company's top line and some dollar weakness plus the company's impending cost cutting measures will definitely help the bottom line here. The price of oil is crucial here as it has the power to bring down equity markets which central banks won't allow. Therefore, if the Fed has to ease again because of declining consumption in the US, American Express stock would act as a natural hedge in that declining US card services revenues would be offset by rising international revenues.

To sum up, American Express in my opinion still warrants being a long term investment despite lower guidance being announced for 2016. It's brand, elevated cash flows and high return on equity illustrate to me that it will return to growth on the back of elevated investment and cost cutting measures. The company is slowly building equity which has always returned much higher returns than US banks for example. I

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  • I do not have any business relationship with the companies mentioned in this post.
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