Friday, April 24, 2009

American Express (AXP) Not too Shabby Earnings; It's Not Capital One Financial (COF) or Discover (DFS)

I've been writing the past two weeks that I can now, after closing out a short position in the stock [Apr 8, 2009: Closing American Express Short] and after reading a quite excellent story in Barron's, make a bull case for American Express (AXP) as it has some differentiation from Discover (DFS) and Capital One (COF). We can remove AXP from the trio of death and perhaps make it a duo of death. [Feb 18, 2009: Trio of Consumer Death in Credit Card Market Marches On] I proposed a potential hedged long AXP / short DFS or COF strategy - but that does not work in this type of market where all stocks in the same sector are "identical" to program trades / quant funds. The HAL9000s of this market just jump in and out of sectors and all boats are lifted by the tide they create.

For example, just last week, COF reported a nasty increase in default rate [Apr 15: Capital One (COF) Defaults Continue Their Upward March] - the stock fell 10%; than late in the afternoon (same day) American Express reported "ok" numbers for their defaults, and Capital One (which last I checked is NOT American Express) rallied 10%. As if the numbers COF reported hours earlier vanished into thin air. And this is why this market leads to constant exasperation - those of us who rely on a fundamental basis are mocked.

So assuredly, as American Express reported a nice beat and solid earnings report (all things being relative) so will rally the other two. Because they are identical (not). More on the last comment later in this piece. First let's see what American Express reported last night...
  • American Express Co (NYSE:AXP - News), reported better-than-expected earnings on Thursday as it slashed costs, and said it intended to repay government bailout funds as soon as regulators allow, sending its shares up 6 percent.
  • In the first quarter, net income available to common shareholders fell to $361 million, or 31 cents per share, compared with $985 million, or 85 cents per diluted share, in the same quarter last year. Excluding an after-tax gain of $136 million from legal settlements with Visa Inc (NYSE:V - News) and MasterCard Inc (NYSE:MA - News), the company posted earnings of 20 cents per share, beating analysts' average forecast of 14 cents, according to Reuters Estimates.
  • Revenue fell 18 percent to $5.9 billion, but expenses fell 22 percent to $3.6 billion, helped by the restructuring plan.
  • The company said it expects another round of cost cutting in the second quarter, which follows efforts in October to cut costs by $1.8 billion through eliminating 7,000 jobs and lowering marketing and advertising expenses.
  • In February, the company took the unusual step of offering $300 to U.S. card holders to pay off their balances and close their accounts, in an effort to reduce its credit risk. Those efforts may have contributed to the 16 percent decline in spending volume on its cards. Spending volume on its cards globally fell 16 percent to $139.2 billion from the same quarter last year, but the company's outstanding cards rose 4 percent to 91.6 million.
  • American Express long catered mainly to wealthy consumers, but earlier this decade it began reaching out to a wider range of clients, resulting in rising loan losses.
  • "While we did see some recent improvement in early delinquency rates, overall credit indicators reflected rising unemployment levels and the broad-scale weakness in the economy," Chenault said.
  • American Express said it hopes to repay the (TARP) funds if regulators allow and after the stress tests, the results of which will be announced for all banks in coming weeks.
  • AmEx took a $1.80 billion provision for loan losses, 49 percent higher than its provision in the first quarter last year. In American Express' U.S. card service business, charge-offs -- the annualized rate at which the company wrote off bad loans during the quarter -- rose to 8.5 percent from 7.0 percent in the previous quarter. The charge-off rate is likely to rise by anywhere from 2 to 2.5 percentage points in the second quarter, and another half a percentage point in the third quarter, the company said. (sounds about right to me)
  • The company also generated $3.5 billion of new deposits and ended the quarter with $25 billion of excess cash and securities. AmEx said it plans to continue to fund 2009 operations primarily through deposits.
So the strategy is clear - more defaults coming but we're trying to get rid of exposure with the payoffs, plus as our revenue shrinks from these actions, we're cutting expenses even more. Can't fault them for that and in fact it's the thing to do - hunker down, survive, and wait it out. With the 1x gain that is not repeatable so does not count on an ongoing basis they made 20 cents in a quite bad environment. The bear case is the securitization market is completey dead but that's where the Federal Reserve comes in, which now seems willing to backstop anything.

Here is the key statement and I think where all the bulls are missing the forest for the trees. As I've stated countless times in the past 1.5 years+, this is an abnormal recession which has been caused in large part by housing. Usually housing is the LAGGING issue, not the LEADING issue. So we have a 2 part recession - the first part (still ongoing) was the housing (atypical) and now we begin the (typical) part.
  • CFO Dan Henry said during the company's conference call late Thursday that even though the housing downturn was a primary driver of higher delinquencies and charge-offs early in the cycle, at this point, "I really think that unemployment has taken over," as the primary driver of card losses.
So the NEXT leg of the housing downturn would be what we EXPECT to happen as a lag effect of a recession. But instead bulls seem to think it has disappeared - we're almost done with the housing because the magical Fed head can push rates to any rate he wants and make our problems go away. Yes that helps at the margin but we still have to get through the housing bust part deux, the part that comes in every recession. And we're still working through the "bad mortgage" housing bust. Anyhow, this is where I mention green shoots abound and please ignore everything I just wrote. The all knowing stock market (Oracle like in its all knowing ways) certainly is.

So my "bullishness" is a relative game - it is in comparison to the (somewhat) peer group. Let's say even with the increased delinquencies coming, AXP can manage to keep printing 20 cent quarters (aggressive forecast on my part) - thats .80 full year EPS and at $22 we have a huge forward multiple for a company which is shrinking. Even at a 5 year growth rate of 10%, this is very expensive - assuming AXP can normalize to a $2 EPS (when? I don't know? 2010? 2011) we are already paying >10x forward earnings on those years. Expensive - but compared to the mess that is Capital One Financial "it's all good"

Capital One Financial (COF) reported Tuesday - let's compare...

Via Reuters
  • Capital One Financial Corp (COF), a leading issuer of MasterCard and Visa credit cards, reported a higher-than-expected first-quarter loss on Tuesday, hurt like most of its rivals by growing credit losses and higher provisions for bad loans. The company posted a quarterly loss available to common shareholders of $176.1 million, or 45 cents per share, compared with profit of $548.5 million, or $1.47 per share, a year earlier. Capital One also reported losses from continuing operations of 39 cents per share. On that basis, analysts expected a loss 4 cents per share, according to Reuters Estimates.
  • Total revenue fell 26 percent to $2.88 billion from $3.87 billion. Analysts expected revenue of $4.17 billion. (disaster)
  • In the U.S. credit card business, charge-offs -- debts the company believes it will never collect -- increased to 8.39 percent in the first-quarter from 7.08 percent in the fourth quarter. (similar to AXP but there is a reason to take more heart in the AXP percentage - later in the piece)
  • "Bankruptcies were higher than expected, increasing charge-offs directly. Recoveries on already charged off debt were lower than expected," Chief Executive Richard Fairbank said in a conference call with analysts. (but other than that, green shoots abound)
  • Capital One estimated that on a monthly basis, its U.S. credit card charge-off rate could climb over 10 percent in the coming months. It stood at 9 percent in March.
  • Capital One said managed charge-off losses will be higher than the $8.6 billion estimated for 2009, but declined to give an specific outlook, "given significant uncertainty in the economy."
  • "I was expecting a negative number, but not the number they posted. It reflects the economic climate that we are facing right now," said Keith Wirtz, president and chief investment officer of Fifth Third Asset Management. "It suggests we should brace for more bad news as the year continues in those areas that are consumer sensitive," Wirtz said.
Via AP
  • Net chargeoffs at the company grew to $1.1 billion from $767 million in the first quarter of 2008. The rate of chargeoffs to total loans jumped to 4.41 percent from 3.07 percent. The rate of loans delinquent by 30 days or more to total loans also grew, rising to 3.99 percent from 3.26 percent.
  • The nonperforming asset rate jumped to 1.91%, from 0.62% a year ago and 1.39% in the fourth quarter.
  • Meanwhile, the company reported strong deposit growth during the quarter. Total deposits increased to $121.1 billion from $87.69 billion at the end of the prior-year quarter. In December, Capital One announced plans to buy Bethesda, Md.-based Chevy Chase bank for $520 million in cash and stock. The deal, which closed in the first quarter, added $14 billion in deposits, as well as branches in Maryland, Virginia and Washington, D.C.
  • Capital One's auto finance business reported net income for the quarter of $71.4 million, compared to a loss of $82.4 million in the year-ago period.
So the only real positive are higher deposit growth which to some degree will let them fund some cash flow, and for some odd reasons auto finance improved. But as shown by the tremendous loss, they have not been cutting costs aggressively enough.

There appear to be differences among these two companies, but not to this type of market where fundamentals are tossed aside on broad themes. Do you really see any difference in these charts?


Now the one area that they seem alike is the % of delinquents - both companies jumped to mid 8% range - this very comprehensive Barron's piece addresses that issue, along with 1 other that caught my attention and allowed me to differentiate AXP from the other two. It's a very in depth story so you can follow the link if you are interested, but I am only going to snip a few things.
  • American Express' outlook isn't nearly as hopeless as is commonly thought on Wall Street. For one thing, unlike its peers, the company gets the bulk of its revenue and earnings from fee income generated by transaction volume, not the extension of credit. This is because charge cards, which are supposed to be paid off monthly, make up a substantial share of American Express' volume. AmEx therefore has substantially less credit risk.
  • AmEx seems to have ample liquidity to ride out the current economic downturn without having to dilute shareholders by selling stock.
  • MUCH OF AMEX'S RESILIENCE to tough times comes from a business model that emphasizes lower-risk transaction-fee volume rather than lending, according to Fox-Pitt Kelton analyst Bill Carcache. Last year, for example, AmEx cardholders used their charge and credit cards to buy $683 billion worth of goods and services, a volume that dwarfed that of their competitors. Chief among the transaction fees generated by this prodigious volume is the industry-high 2.5% fee that AmEx typically charges merchants for access to AmEx's big-spending cardholder population.
  • AmEx gets to keep the bulk of this fee income, since unlike most card sponsors, the company runs a closed-loop network in which it issues and markets cards, handles all transaction processing and even "acquires" and directly pays off all its merchants around the globe. Most bank issuers have to share their merchant fees with the likes of Visa (V), MasterCard (MA) and First Data.
So the above is not "new"; we knew that - it was just the magnitude that struck me.

Now onto more differentiation
  • Much of the investor concern over AmEx arises from the sudden surge in delinquencies and, even more damaging, loan charge-offs in excess of the company's competitors. This wasn't supposed to happen at American Express, given the company's more affluent customer base. Yet after lagging behind industry averages for most of 2008, charge-offs at AmEx began to skyrocket in the fourth quarter, according to closely watched monthly performance data taken from the company's major credit-card-receivables securitization.
  • The jump in AmEx loan defaults, however, may not be as telling as it first appears. The rates of late have been pushed higher by a wicked denominator effect, as management began reducing outstanding credit to U.S. consumers in the second half of last year by cutting credit lines and raising interest rates and fees on accounts.
This was a great point - as they reduce outstanding credit, the denominator shrinks, and hence the nominal bad debt in the numerator "stays", and the % increases. So while both AXP and COF have mid 8% delinquent rates, there is a lot better explanation (in theory) for AXP. This was a potential game changer in my eyes.
  • The efforts earned AmEx some bad press for its hard-nosed tactics but enabled the company to reduce its U.S. credit-card receivables total (the denominator of the charge-off data) to $57.8 billion at the end of February from $65.9 billion at year-end 2007.
So we have a nice 15% reduction in "credit exposure" in just over a year, which is contributing to the higher delinquency rate (to some degree). Now with that said, all credit card arms/companies seem to be cutting back credit but I don't have the data on the others (many are locked inside of much larger companies like JP Morgan and Citigroup)... but I don't recall anyone else sending $300 'gifts' to people to please close their account. [Feb 24, 2009: American Express to Customers to its Customers: Please Go Away. Here's $300 to Spur You to Leave]

Again, in a normal rational market I could make some case (on a pullback) to go long AXP and marry it to a short of the more pure plays (with higher credit risk and less transaction fee) credit card companies. In this market? Who really knows what to do anymore since the program trades determine our fate on an hourly basis.

Here is a bull/bear case between analysts via Fortune as well

Short Capital One Financial in fund and personal account

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