- American Express recently announced a deal to sell its Costco Portfolio to the Citigroup.
- Loss of the Costco deal has been haunting American Express investors from the past one year.
- American Express is likely to see muted growth in the next few quarters.
American Express (NYSE:AXP) recently announced a deal to sell its Costco portfolio to Citigroup, at an undisclosed price. The deal will be closed by July 2016. A little more than a year ago, Costco ended its 16-year old exclusive partnership with American express for its co-branded cards and replaced it with Citigroup. Costco also replaced American Express with Visa as its preferred card network.
Already facing stiff competition, from existing and new players, and a challenging global economic environment, the missed deal had sent American Express stock into a tailspin. American Express stock is currently trading at $57.12, down more than 30% since last February.
What spooked investors was that Costco customers accounted for 10% of its 118 million credit cards. As feared, the loss has had a significant impact on American Express' growth and profitability.
Both revenue and profitability saw a decline in 2015 compared to 2014. For 2016, American Express has guided for an EPS between $5.4 and $5.7. While this is higher than $5.06 achieved in 2015 and above analysts’ estimates of $5.47 for 2016, it includes the one-time gain from the sale of its Costco portfolio. While the deal value has not been disclosed, it is expected that American Express will gain $1 Billion from this transaction
The one time gain from Costco portfolio will be contributing around $0.7 ($1 billion less taxes at 35% spread over 970 million shares) to the 2016 EPS. Adjusted for these gains, EPS guidance would have been at a considerably lower range.
American Express has also revealed that 23% of $1 trillion in card spending in 2014 were from co-branded cards. This is another cause for concern. If its competitors could outbid American Express for the Costco deal, they could do it for the other co-branded deals. The effort by the management to reduce its cost structure is likely to make American Express more competitive and address this concern to some extent.
American Express Stock A Value Buy?
The decline in stock price has pushed up American Express' dividend yield to 2.18% much higher than its rival Visa and brought down its PE (ttm) to 11.3, far below the credit services industry average and competitors like Visa and Master card.
While American Express definitely looks cheap at its current valuation, we must also keep in mind its growth and operating margin. The company's current revenue growth and profit margin is below its five-year average. While American Express revenue declined by 4.3% in 2015, Visa saw an increase of 9% in its revenues. Also, American Express saw its operating margin decline to 28% in 2015. Even its return on equity has declined from 29% in 2014 to 24% in 2015.
Strong Cash Flow Position
However, one metric where American Express remains strong is its cash flow position. Notwithstanding the slowing growth, American express generated $9.6 billion in free cash flow and more than $10 billion in operating cash flows in 2015 with free cash flow margin at an impressive 17%.
The strong cash flow allowed American Express to return $5.6 billion to its shareholders in 2015, representing 58% of its free cash flows. At this level, American express can sustain its dividends payout and share buyback programs. Considering American Express' market cap of $55 billion, total shareholders yield was around 10%.
The loss of the Costco deal will continue to have a significant impact on American Express’ growth and profitability in the next few quarters. The company will continue to face serious challenges on the macroeconomic front as well as from technological changes within the payment industry. With stiff competition within the industry, American Express is likely to experience muted revenue growth in next few quarters. However, with the global move towards a cashless society and a strong cash flow, American Express has a lot of potential in the long run. Get into American Express stock only if you have log term investment horizon.