How risky is American Express?

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Credit card company American Express (NYSE: AXP) endured a tough 2020, like many in the financial services industry, but fared better than most. The share price fell only about 1% last year, which isn’t bad considering the coronavirus pandemic and associated recession have caused spending to drop sharply and virtually shut down the travel industry.

The company is in a much better position to grow in 2021 and beyond, as the stock price is already up more than 4% since the start of the year. But that doesn’t mean the stock isn’t risk free. Let’s see where the business is heading.

A difficult year 2020

American Express is a credit card company, but unlike Visa and MasterCard, it does not issue its credit cards through banks. American Express has its own financial network, lending money to the card user with reimbursement at the end of the month. Thus, he earns money on member or card user fees, merchant transactions and interest income.

Image source: Getty Images.

American Express’s stock price fell about 1.1% in 2020, which underperformed its peers, both of which saw their prices rise by about 20% in the same time frame. same Discover financial services, the fourth largest credit card company after Visa, Mastercard and American Express, outperformed American Express. Discover is a more direct comparison because it also has its own financial network.

There were several reasons why American Express was lagging behind the competition. While all have been affected by the decline in consumer spending, American Express has been particularly affected as it derives a significant portion of its revenue from travel and entertainment expenses. These two segments were decimated by the pandemic, hence the sharp overall drop in turnover.

For the year as a whole, discount revenue, which is the company’s main source of revenue, fell 22% to $ 20.4 billion. Discount income is the money he earns from merchant transactions. Interest income on loans, the second-largest revenue line, generated $ 9.8 billion for the year, down 14%. The only segment that recorded gains last year was card fees, which rose 15% for the year as a whole to $ 4.6 billion. These fees, which vary by card, provide members with rewards and discounts, and are one of the main benefits of being a card member.

Total revenue for 2020 fell 17% to $ 36.1 billion, while net profit or profits fell 54% to $ 3.1 billion. The decline in income related to income is largely explained by a high allowance for credit losses in the first three quarters.

One of American Express’s big risks that its bigger competitors don’t have is credit risk. As a bank, in fact, lending money to members for purchase, it is open to defaults. This led American Express to set aside $ 4.7 billion for expected credit losses in 2020, 32% more than in 2019. It weighed heavily on profits.

However, in the fourth quarter, profits fell only 15% due to the lack of reserve building. In fact, American Express had a provision benefit of $ 111 million due to a reserve release of $ 674 million caused by an improving macroeconomic outlook and strong credit performance.

Improved outlook for 2021 and beyond

The credit risks that led to the high allowance for credit losses are expected to be greatly reduced in 2021. The company has already seen this in the fourth quarter. American Express Chairman and CEO Steven Squeri said during the call for fourth quarter results that defaults and write-offs during the quarter were at “the lowest levels we’ve seen in a few years and best-in-class.” With the expected improvement in the economy, the reserves currently on the books should be adequate, barring another significant economic downturn. As a result, reserve build-up is expected to be significantly lower than it was in 2020.

Travel and entertainment (T&E) spending is also expected to rise, in line with pent-up travel demand and an economic recovery. In the fourth quarter, non-T&E spending actually increased 4% year-over-year, but T&E spending fell 65% year-over-year. And that’s an improvement over the previous three quarters. The most of American Express T&E Expenses comes from consumers, not businesses, and the consumer segment is expected to recover faster than the business segment. American Express CFO Jeff Campbell told the call for earnings that he expects non-T&E spending to increase:

But more generally in 2021, our overall recovery in volume to pre-pandemic levels will be mainly due to what’s happening with T&E as non-T&E have already made a significant recovery. While we currently expect spending in Q1 2021 to remain relatively in line with Q4 2020, up to some impact from normal seasonality, our current assumption is that by Q4 2021, T&E spending will have recovered to about 70% of Q4 2019 levels.

Thus, the market risk will also be reduced upon exiting the recession. American Express should not only benefit from pent-up travel demand, but also from the pursuit tendency to abandon cash, accelerated by the pandemic. The company is also well capitalized with a Class 1 common stock ratio of 13.5%, well above the regulatory minimum and up from 10.7% in the fourth quarter of 2019. In addition, it has increased its 38% cash position to $ 33 billion. . The business is in a much better – and less risk – position at the start of 2021 than it was a year ago.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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About Nereida Nystrom

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