We have reiterated our Neutral outlook on American Express Co. (AmEx) ( AXP ) based on its improved earnings growth momentum in the first half of 2012, despite the loss of litigation settlement payments from MasterCard Inc. ( MA ) and Visa Inc. ( V ).
However, concerns remain over expense control amid a higher provision for losses and intense competition.
AmEx reported second-quarter 2012 operating earnings per share of $1.15, higher than the Zacks Consensus Estimate of $1.10 and last year's $1.07.
AmEx continues to benefit from an improved credit quality with an increased usage of cards and fewer defaults across all business segments. A superior market network and moderate growth in the spending and loan portfolio also drove the net interest income. However, healthy top-line and earnings growth were partially offset by a higher-than-expected provision for losses and expense growth, a higher tax rate and a lower return on equity (ROE).
AmEx holds a leading position in the high-growth card payment and lending arenas, and has the ability to achieve strong inorganic growth despite sluggish progress and regulatory hassles in the industry. The company has the potential for increased market penetration, merchant acceptance and brand recognition as it is expanding its list of network partners. Its Global Network & Merchant Services business has been performing very well, with billed business or spending on cards growing at a modest rate.
Moreover, after witnessing several quarters of downturn, net interest income and loan portfolio started showing improvement. Healthy and intelligent spending among customers has aided the company in recording the lowest default rates in 2011, which are expected to continue into 2012. Going ahead, the company's adjusted expenses are expected to decline, owing to cost containment measures and improved operating leverage. These consistent efforts are expected to help support the bottom line significantly.
An enhanced operating leverage helped AmEx enjoy a strong capital position with a Tier 1 risk-based common ratio of 12.8% at the end of the first half of 2012, well above the current regulatory requirement under Basel III. Armed with excess cash and securities of $16.3 billion at the end of the second-quarter 2012 along with a strong operating cash flow, the company remains sufficiently liquid to finance its $14.8 billion in funding maturities through June 2013. Moreover, improved operating performance has paved the way for growth in book value per share, a dividend hike and higher share buybacks.
Management expects to consistently invest 50% of its excess capital in the business while paying out the remaining 50% to investors through dividends and share buybacks.
On the flip side, despite the gradual global economic recovery, the company's net interest yields continue to be sluggish, reflecting lower revolving levels and lower balances at penalty rates due to improved credit performance. Furthermore, a low interest rate environment continues to threaten the AmEx's total interest income growth as investment securities continue to fetch poor returns.
Moreover, as the credit cycle normalizes, the company is more focused on returning capital to investors rather than investing for business diversification, which will slow the growth rate in the near term. Meanwhile, the loss of litigation settlement payments from MasterCard and Visa is likely to mount additional pressure on the bottom line in 2012.
In addition, provision for losses jumped to $873 million in the first half of 2012 against $454 million in the year-ago period, after reducing to about $1.1 billion in 2011 from $2.2 billion in 2010 and $5.3 billion in 2009. An upside in the provision for losses is further expected for 2012, given the lower reserve release. An adverse spending capacity, along with intense competition, a decline in discount rate and litigation expenses among others, can further accentuate operating risk. Hence, going forward, the company has to put a tight lid on its expenses in order to maintain and expand its margins along with bottom-line growth.
Based on the pros and cons, the Zacks Consensus Estimate pegs earnings for the third quarter of 2012 at $1.08 per share, which is about 5% higher than the year-ago quarter. For 2012, earnings are expected to climb about 7% over 2011 to $4.40 per share.
AmEx currently retains a Zacks #3 Rank, which translates into a short-term Hold rating and long-term Neutral recommendation on the stock.