Is it time to buy American Express?
The credit card giant has been hit hard by consumer woes, driving the stock down to 1997 levels.
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| The Bear: Don Fandetti of Citigroup |
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| The Bull: Robert Napoli of Piper Jaffray |
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NEW YORK (Fortune) -- American Express is feeling the consumer's pain. In the fourth quarter of 2008 the credit card giant's earnings fell 79% from the year before as consumers spent less, more customers failed to make payments, and charge-offs for unrecoverable debt increased.
Of its four main businesses - including international and corporate credit cards, and expense management - the U.S. credit card business has been hit hardest.
To adjust, the company has slashed expenses and reduced credit limits for some cardholders. But still, its stock, down 52% over the past year, now trades at 1997 levels.
Is AXP (AXP, Fortune 500) a value at this price? We asked two analysts for the answer.
The first words out of any investor's mouth about American Express are, "They grew too fast from 2005-07." We rate it a hold.
They have more exposure than other credit card companies in hard hit regions like California and Florida. And they tend to service the higher-end consumer. That's where this downturn is different than others. Spending, in particular discretionary spending, is slowing on the high end.
One key is that AmEx did not take a big write-down last quarter. It needs to do that at some point in 2009 to account for higher charge-offs. Charge-offs are going to go up to around 12% in mid-2010, from 8.6% in February.
The other problem is the consumer. AmEx's billings will fall by a high single-digit number this year. In the last quarter it was down 10%. There's going to be an extended period of less spending. And AmEx is very leveraged to spending trends - half of its revenues come from its billed business and the fees charged to merchants when members make purchases. The savings rate already moved up to the 5% range from being negative. The consumer is deleveraging, just like a hedge fund.
One positive is that there is anywhere from $8-$15 of per-share value from the card network processing business. That will support the stock.
Once investors get comfortable with the economy, they're going to want to buy this stock - it's a great brand and company. But it's still too early.
The key, and what people are missing, is that American Express can handle high charge-offs and still generate profits. Historically, it has traded at 20 times normalized earnings. If you believe earnings power is $3 a share when the economy stabilizes - in mid- to late-2010 American Express should be earning at historical levels as we get through this - we're now trading at five times earnings power.
American Express can remain profitable at a 12% U.S. unemployment rate for a full year. It's not easy. But because fee income from its credit card processing business is 80% of revenues, they're much less credit sensitive than other credit card companies like Capital One (COF, Fortune 500), for example. If unemployment goes up 1%, and spending goes down, that has three times the negative effect on Capital One's earnings than it does on American Express's because of all the fee income that American Express generates.
I admit American Express screwed up. It grew too fast from 2004 through 2007. Still, it did not loosen credit to a significant extent. Its customer base is a premium customer base, and its average FICO score has not changed much from prior to the cycle to today.
The economy is not free falling like it was three months ago. So as that $3 earnings power becomes clearer, the more dangerous being bearish on it is.
Also, the company is cutting out $1.8 billion of expenses this year and restructuring. These are permanent expense cuts. I'm not saying it all goes to the bottom line, though it could. Our target price is $36. 
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