American Express: Strong Company, Weak Brand
The best way to think of American Express (NYSE: AXP) is as a very strong company with a very weak brand. Even though the company’s fundamentals and financials are good, it is slowly being dragged down by a poorly performing brand.
This is why Amex’s financial numbers for Fourth Quarter 2015 are such a mixed bag. Many of those numbers actually look great, including:
- A net income of $5.163 billion.
- A profit margin of 10.71%.
- A dividend yield of 2.12%.
- A free cash flow of $3.431 billion.
- A return on equity of 26.95%.
- Cash and short-term investments of $19.94 billion.
- $10.48 billion in cash from operations.
American Express: Value Investment or Value Trap?
These numbers make American Express look like a classic value investment because it generates a lot of cash. Yet it might be a value trap because of the drop in revenues and the collapse in share prices.
Amex’s revenue is actually far healthier than the chatter out in the blogosphere might indicate. The company reported a TTM revenue of $32.82 billion on December 31, 2015, while Visa (NYSE: V) reported a TTM revenue of $14.06 billion on the same day, less than half of American Express’s.
American Express’s revenue is impressive because it had only around 38 million cardholders in 2014, while Visa had 109 million, according to Statista. That indicates Amex is making a lot more money from its customers, which means its cardholders have more value than its larger competitors.
Yet that revenue also shows why American Express could be a value trap. That revenue declined by $1.47 billion in 2015. In December 2014 Amex’s revenue had risen to an all-time high of $34.29 billion, but it fell all year long, largely because Costco Wholesale (NASDAQ: COST) ended its exclusive arrangements with American Express.
The danger here is that American Express’s brand has entered a death spiral that will keep dragging the revenue down. It is not clear that this is going to happen, but Mr. Market thinks it is. Amex’s share value has taken a terrific tumble over the past month.
On December 29 American Express was trading at $70.55 a share; on the morning of January 29, 2016, it was going for $53.46 a share—a loss in value of $17.09 a share. Not surprisingly, the real damage was to American Express’s market capitalization. On December 29 Amex had a market capitalization of $69.44 billion, which had fallen to $52.61 billion just a month later. That makes for a $16.83 billion loss of market value in just a month.
So Is Amex a Value Trap?
So it is easy to see why many observers consider American Express a value trap. Yet many others might look upon it as a value investment because of the low price. American Express is definitely undervalued right now because it had an enterprise value of $83.92 billion on January 29.
The numbers make it appear that Amex is a value, but it is the weak brand that makes it a value trap. The American Express brand simply lacks the value it once had; it is no longer strong enough to hold business relationships or bring in customers. It is obvious that Costco, which is a value-obsessed company, no longer thinks American Express is more valuable than other credit cards like Visa.
What is interesting is that American Express is still a very well-run company that brings in a lot of money. It simply can no longer rely on its brand name to attract business like it once did. The company needs to utilize other methods such as promotion and new relationships.
One way it is doing this is with an aggressive push into payment apps such as Apple Pay and Android Pay. Unlike Discover, Amex was on those apps from the beginning. American Express is also working hard to promote payment applications on its own. It started hyping Apple Pay’s entry into Canada before Apple itself did.
American Express Is Definitely a Value Buy
This indicates that American Express is not a value trap, because it is a strong company. My take is that American Express’s share price will bounce back once its revenue stops falling. The telling thing will be how much the revenue falls this year, because that will tell us how much its business was reliant on Costco.
Therefore American Express is a value investment because of its strength as a company. It has a good basic product, a good management team and impressive capabilities, particularly in technology. More importantly, it has a lot of cash and tremendous resources.
That means American Express is still a good investment even though it has a weak brand. The moral of the story is that a strong company can offset a weak brand, but a weak company can undermine even a great brand. For an example of a strong brand being dragged down by a weak company, see McDonald’s.
The weak brand could be what makes American Express a true value investment right now because it is a deceptive company. Even though the brand is weak, the company is strong, and it’ll keep generating a lot of cash for years to come.