American Express (NYSE: AXP) stock was doing fairly well this year until mid-October, when it posted its third-quarter earnings. Investors accustomed to solid results in the quarter from other top names in the finance sector bailed out of AmEx, clipping the wings of a stock that had been soaring year to date.
Like Warren Buffett, whose Berkshire Hathaway has held a major equity stake in the company since 1964, I’ve been an AmEx bull for years. So to me, that post-earnings price dip is an anomaly, and by no means the new normal for the credit card giant. Here’s why.
To briefly summarize, AmEx’s net revenue for the period grew by 8% year over year to $16.6 billion, while its net income inched up at a 2% pace to $2.51 billion.
That bottom-line figure was comfortably above the consensus analyst estimate. However, AmEx had the temerity to land just short of the average pundit revenue projection of nearly $16.7 billion. This earnings season, a miss on either headline metric is the exception rather than the rule in big finance; most major nationwide banks, for example, beat on both.
AmEx watchers digging into the specifics of the company’s quarter found another source of discomfort: reserves for credit losses. This line item, which details how much a financial company is setting aside for loans that might go bad, grew a relatively steep 21% to $5.3 billion.
The combination of the two factors suggests to those of a bearish cast that AmEx’s vaunted base of affluent “members” (the company’s fancy term for cardholders) reined in their spending. Worse, the credit card king was counting on a notable rise in delinquencies across future periods.
Here’s the thing, though: Businesses in the money-lending space, which includes credit card issuers like AmEx, tend to be conservative in their financial practices. They have to be, as lending funds is an inherently risky activity, no matter how solvent or wealthy the borrowers.
Zooming out for a top-down view of the macroeconomy, the Federal Reserve recently enacted a 50-basis-point cut to its federal funds target rate, and fresh cuts might come soon. Broadly speaking, lower rates mean more borrowing (including credit card spending). It feels to me, then, that AmEx and other financiers are bulking up their reserves as a hedge against a pop in borrowing. This company’s fate is tied to that of its lending, after all.
And it’s a very good lender. As both the issuer and the payment processor behind its cards — in contrast to Visa and Mastercard, which are purely processors — AmEx has deep and wide knowledge of its members. Using its Rewards program, ever a follow-the-leader model for other issuers, it can sharply target members to entice them into spending more.