- Although I am bullish on Amex , I feel the stock will fall in the near term due to the US dollar about to embark on a multi-week rally.
- The Global Commercial Division top line grew by 2% in dollar neutral terms. Net income which was down 6% will increase from here.
- Amex has an excellent track record of returning capital. The float came down by 6% last year and the dividend will continue to grow.
Many bearish American Express (NYSE:AXP) analysts and investors alike believed that the loss of the Costco and JetBlue deals would have derailed American Express's trajectory over the next few years. However, this has proved untrue as the first quarter showed that excluding Costco's business, global business actually went up by almost 7%. I have been bullish on American Express stock for quite a while mainly due to its fundamentals and valuation and now its recent earnings report has convinced me even more. Why? Well, its loan balance expanded by over 10% in 2015. I acknowledge that expenses grew by almost 20% and card member services grew by 8% which are definitely headwinds in the near-term. Furthermore, the dollar is proving to be a headwind because American Express derives around 40% of its revenues from international markets.
However, Amex currently has strong tailwinds (such as continued e-commerce growth and loose credit conditions) which should keep the top line elevated. I still believe American Express stock will trade at an earnings multiple of around 15 (13 presently) which should spike its share price to around $75 a share in forthcoming quarters. Let's go through why a short-term top may be imminent and also why I still believe that the stock has plenty of upside left in it.
So why could American express fall in the short term? Well as mentioned earlier, Amex derives around 40% of its top line from international divisions meaning any fluctuations in the dollar significantly affects the top line. Furthermore, since the dollar is in its timing band for a daily and intermediate cycle low, the lows printed on the 11th of April may well turn out to be an intermediate cycle low. Now intermediate cycles can last for 20+ weeks meaning that if the dollar index stays above the 94 level over the next week or so (presently 94.76), I'm pretty sure this would mean a firm intermediate bottom would have been printed in the dollar. This is bearish for Amex going into the Summer. Now is not the time to get long especially considering the run-up the stock has had recently. Wait for a pullback before re-entering
So why do I like the fundamentals of American Express? Well, its two biggest international divisions are "International Card Services" and "Global Commercial Services" which make up 46% of overall revenues respectively. What I like is that although net incomes are declining in these divisions due to higher spending, revenues on a currency neutral basis are increasing (8% in card services and double digits in Global Services). In fact, Global services saw 2% growth in its top line in dollar-neutral terms to $2.4 billion (see chart). This is why the street is valuing this stock differently. The investments and spending the company is undertaking are bearing fruit and once spending starts to ease off and the dollar weakens after the Summer, then this stock could easily make its way to over $75 a share.
Investors also shouldn't underestimate the strength of the American Express balance sheet which is enabling the company to invest through this cycle in order to grow faster in the future. Long-term debt has actually fallen from $54.71 billion 12 months ago to $47 billion this quarter. Equity is flat year on year at $21 billion and once net income rises once more ($1.426 billion announced this quarter), return on equity percentages will return to former averages of 28+%.
Furthermore, the company continues to return a sizable amount of cash flows to its shareholders in the form of dividends and buybacks. The float was reduced by 6% last year and since the pay-out ratio is just over 20%, there is ample room for the credit card company to keep increasing its dividend. Astute investors know what a cash flow machine this company is and with a present price to cash flow ratio of 6 which is more than half its historic average, American Express stock will continue to remain in strong hands.
To sum up, American Express may fall in the short term due to elevated spending and dollar strength but these headwinds will eventually dwindle which should boost return on equity percentages once more. I like the growth we are seeing in Global Commercial Services in that its top line is vastly outperforming expenses and initiatives. Watch card member spending and marketing expense closely in forthcoming quarters. If they keep on increasing, it means its premium brand is coming under pressure. However, I feel that eventually these expenses will at least flatten out which will improve profitability for the firm.