American Express (AXP) is scheduled to report earnings on October 23, ahead of the opening bell. However, don’t expect the company to impress. Analysts have certainly kept the bar low: expectations for YOY decline in revenues are set at 21% and EPS at 36%.
In this article, I will briefly address earnings expectations. After that, I will explain why AXP is my “favorite terrible stock”: one that is likely to endure quite a bit of volatility and potential losses in the short term, but thrive in the longer term as the company eventually rebounds from the depths of the 2020 crisis.
(Image Credit: CardMapr)
The quarter ahead
To understand what American Express’ third-quarter results might look like, it helps to take a step back and look at the company’s second-quarter earnings. Back then, when EPS dropped YOY by a whopping 85% and revenue decline set a historical record, I pointed out that “nothing had worked in the quarter”. Unfortunately, I do not expect the third quarter of 2020 to be directionally any different.
Below is Amex’s revenue split and growth (or decline) rates in 2Q20. The key driver of the company’s discount revenues, the largest piece of the pie, is billed business. While I expect some sequential improvement here, the T&E space (i.e., restaurants, lodging, and airlines) remains well off its pre-pandemic normal. I expect the numbers to look ugly once again, although very likely not as much as they did last time.
(Source: DM Martins Research, using data from 10-Q)
The other meaningful component of revenues is net interest income. Here, American Express will likely be hit from both sides: (1) low interest environment squeezing net margins and (2) consumers playing defense, which should lead to lower loan balances.
Regarding the latter point, I was impressed (and a bit disappointed) to see all major consumer banks report a substantial decline in this important metric (see chart below). To me, this is a definitive sign that the consumer has not been willing to lever up, especially in a tough economic environment. American Express’ consumer base tends to lean wealthier and less dependent on government stimulus, which could be a positive for the company this time.
(Source: DM Martins Research, data from multiple reports)
Long-term future still bright
I hold AXP in my All-Equities SRG for a couple of reasons. First, American Express is not a pure-play consumer finance company, as it blends together a bit of Capital One’s (COF) business model, except with a higher-quality loan book, with Visa’s (V) or Mastercard’s (MA). Second, the company derives a good chunk of its revenues from card fees, which tends to be more stable and predictable compared to discount revenues or net interest income.
The problem is that American Express is facing a perfect storm type of crisis in which nothing seems to be working for the company. As a result, shares are currently down 25% from the February peak – justifiably so, if one focuses more on the short-term prospects.
As a long-term investor, however, I am much less concerned. True, low interest rates are here to stay for much longer, which is bad news for banks in general. But once again, remember that the more important drivers of American Express’ revenues are volume of transactions and number of fee-paying cardholders.
I find it highly unlikely that consumer spending will remain under severe pressure over a multi-year period of time, or that American Express will lose its appeal within its target user base. Should this be the case, I believe that AXP will find its way north once again, eventually. Once it does, shares will have 32% to climb only to get to prior all-time highs, suggesting more pent-up share price gain potential than what investors may be able to find elsewhere in the S&P 500 (SPY).
It is this combination of solid long-term business fundamentals and lower share price that keeps me hopeful about buying AXP at current levels and holding on to it for a while.
Beating the market by a mile
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Disclosure: I am/we are long V, AXP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.