Chit Chat Stocks - American Express (Ticker: AXP) Not So Deep Dive

Episode Date: February 28, 2023

American Express (AXP) is a global financial services company that provides payment and travel-related services to consumers and businesses worldwide. The company was founded in 1850 and is headquartered in New York, New York. At the end of the month, we will publish an Arch Capital episode that will cover the company: Nelnet. Listen closely as Brett and Ryan go through the history, financials, and future prospects of American Express. Enjoy the show! ****************************** This episode is sponsored by Stratosphere.io, a web-based terminal for financial data, KPIs, and more. Try it out for FREE or use code “CCM” for 15% off any paid plan. Sign up here: https://www.stratosphere.io/ ****************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (2:23) Industry | (20:47) Management & Ownership | (24:58) Earnings | (30:24) Balance Sheet | (35:02) Valuation | (38:24) Our Analysis | (39:28) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome into Chit Chat Money. My name is Brett Schaefer, and I am joined by my co-host, Ryan Henderson. Today is our Tuesday not-so-deep-dive episode where we analyze

one stock by covering its business model, ownership, financials, and future growth opportunities. After listening to this episode, we hope you get a better perspective on the company we are covering. And today, we are talking about American Express, one of the payment network and credit card giants that is also one of the oldest companies in the world. Ryan is going to get into their history and what they do. But first, before we get to today's episode, this episode is presented by Stratosphere, our investing home screen for fundamental research. and... Whoops, Ryan, you shared the screen there and cut off my script. For fundamental research, Stratosphere has awesome data visualizations, SEC file aggregations, and custom-built KPI tools

that are not available anywhere else. For example, today, we're going to be taking a look at American Express's revenue per share. Ditch Yahoo Finance and up your investing knowledge by using stratosphere.io. We use Stratosphere as our investing home screen, and you can too for free by going to stratosphere.io. That is stratosphere.io. The link is in the show notes if you would like the spelling. Okay, Ryan.

Is that our tagline? Or is that... Did we come up with that? Did Yahoo Finance? I came up with that for our new script, yes. So that is from my brain, yeah. I think it's good. It's definitely a level up over Yahoo Finance.

100%. Yahoo Finance, you don't need that buggy stuff that is usually not accurate anyways. But yeah, Ryan, why don't you get into American Express, what they do? A little bit complicated, but also fascinating. And then the history, which is a fun one because it's almost 200 years old now. Yeah, it's been around for a while. I'm not sure how relevant some of that history is to the business today,

but it's still a fascinating story, nevertheless. So I guess let's start with what they do. you could i i would probably describe american express as a specialty finance company you could say they're consumer finance but they also sell the businesses as well so they offer a lot of commercial or business services um but they are really they operate across the transaction life cycle so unlike a lot of financial institutions which typically focus on a particular segment or sub-segment of the financial industry amex operates really across the whole life cycle so kind of to go back to a typical transaction to give sort of a broader glimpse

someone will insert their card if you're buying let's you know let's say you're buying shoes or something you're gonna the customer is going to insert their card to a point of sales terminal the card is typically issued by their bank and it'll have a card network that that powers it so they'll insert the card in the merchant's point of sales terminal the merchant will get the point of sales terminal from any number of providers american that is probably the one part of the life cycle where american express is not a part of they they don't distribute point of sales hardware as far as i know um and then the merchant acquirer which is generally stripe or addion um also could be american express american express is immersion acquirer as well

sends that data sends the customer's data to the card network so that is where you typically have the mastercard the visa or in this case american express as well um who then queries the original issuing bank so that could have been chase bank of america or american express um for authorization so once it's authorized it'll display some sort of a transaction authorized it has to know that you have like the right amount of funds that kind of thing american express basically operates in every one of those segments so it's got it is the card issuer in many cases it has the bank accounts or it has the availability for bank accounts for their customers it is the merchant acquirer for the actual merchants themselves they process those payments and then they are the card network

so they actually uh are routing the orders to basically themselves it's a closed network um and i think it's the only business i can say with confidence it's the only business in the united states that's an entire closed network correct i think discover might be but they're kind of losing a lot of market share in their various player today if we look at i also don't know exactly discover's business model but it's possible they run the same one as american express but they have in the united states one to two percent market share where american express is is closer to 10% plus. Okay. And then basically American Express performs all those functions. So they make money in predominantly three ways. There's some other ways as well, but these are

really how they break down their business. So the first one is discount revenue. This is merchant transaction fees. So on each transaction where a customer uses an American Express card to pay, the merchant is charged a small fee that gets paid out to Amex. I know it seems small to us, but it might not be small to the merchant. And this is very similar to Visa and MasterCard. Amex charges anywhere from, it'll be like 10 cents fixed. So a 10 cent fixed charge plus 1.6% of the transaction, or even goes as high as almost 3.5%. In some cases, it's estimated that Amex's fees are on average 50% higher than Visa and MasterCard's. However, in the US today, 99% of merchants accept American Express, despite these higher fees, likely because of the

attractiveness of American Express's cardholder base. American Express, generally regarded as a more affluent customer base, people that- Yeah, maybe top quartile for each region, they're kind of going for that wealth of income. And then for reference on that, the fee difference, it has been coming down over time. So it's not as big of a difference today, but that has been a headwind for American Express over the last couple of decades. Yeah. And then that segment, so the merchant fees accounts for about 58% of revenue, at least it did in 2022. The second one, and this one's really unique to American Express. I think there might be some other card companies might offer this, but not quite to the magnitude that

american express does um this is card fees so unlike other card issuers who in my experience tend to give their cards away for free or they're like a one-time kind of charge for the actual card itself american express charges people you know in order for them to be a member of american express so um and it's an annual rate so the rates vary depending on the market there are there is like the blue card or something like that that american express offers that's free there's there's there's no membership fee but in order to have the platinum card which grants you access to like the american express lounges at um airports and there's a number of other benefits as well you have to pay 695 a year in the u.s um and that's been going up over time for the gold card it costs

$250 a year. And then each of these cards kind of comes with your variety of different partner packages, essentially, where you can earn cash back for flights or hotels, or I think on the gold card, you can earn Uber points, they have a big partnership with Delta. And so they have a number of co branded cards that way as well. Anyways, this is 11% of revenue, really high margin. I imagine, I don't think they break it out explicitly, but I mean, they're basically just charging to be a member of their club, essentially. Keep in mind though, they do pay back. There are some expenses in terms of offering the benefits to customers. The last one here, just the last big one, at least, is interest income. This is the more

common way credit card companies make money. American Express charges customers an interest rate on any carried balances in their accounts they also originate simple loans to their card holders so beyond just like the the carried balances they will you know grant them loans and cardholders aren't just as i mentioned individuals it can also be corporations as well so they're giving out those loans um like other businesses though they have interest expenses as well so there's a cost for them to generate those funds to loan out and so in this rising rate environment that we've seen over the last year interest expense has risen a little bit um and so when you see basically there's the interest revenue which is what

they're earning on their loans minus what it costs for them to acquire those funds to lend out um and so that's con that the differential has uh contracted a little bit as rates have risen um and so it the net interest income has shrunk this year however it generally accounts for 19 of the revenue typically when you have a rising rate environment and i'll talk about this in my highlights when you have a rising rate environment and you're a credit card company or you're a lender of some sort your interest income is really going to get squeezed it's happening for american express in some ways but because it's only 19 of their revenue um they're really not as as affected uh because they have such diverse revenue streams the last segment well i guess there's some other

segments as well that are kind of minuscule but there's service fees and other revenue i'm putting that in air quotes um it's predominantly made up of travel commissions so if you go online you can look up american express travel and you can like book your trip through american express travel providers will pay amex or american express kind of a kickback or a commission they don't typically call that out but because of the boom in travel last year revenues jumped by 36 percent um and it's it's made up a sizable portion so they really they and they are kind of just generally tied to um travel and entertainment spending um and so they they get a lot of their spending from that um so this last couple years was really good for them i guess

ultimately what what's important to understand here is american express operates around what management calls a spend centric model it's really based around their cards it's based around people feeling like they're a member when they become an amex cardholder um and and amex kind of monetizes those customers in a number of ways spending lending um and then and then obviously generating that revenue from the merchants as well but when we talk about the history um before anything yeah yeah before you get into it i think just for context for the listeners or the viewers i think this would be a good time to share their total network transactions uh over time just before we get into all the numbers to give some context here so let me just share my screen and i'll

describe it real quick it's super super simple but if we look at um here we have the chart here over at stratosphere total network transactions and this is in millions but regardless it's uh last year, they had about $1.5 trillion. And since 2012, it's generally trended higher and grown at a compound annual growth rate of about 5.7%. You can kind of see in 2015, 2016, 2017, it stalled out a bit. And that's mainly because they lost the Costco partnership then, which we might hit on this episode, might not. And then in 2020, huge dip because travel and spending, I guess, in general, it's like a big bite. American Express was probably more exposed because of the impact on the airline partnerships, the impact on the hotel partnerships. But then in 2021 and 2022, we've

seen a huge rebound. And last year, like I mentioned, $1.55 trillion in total network transactions. And then compared to 2019, at $1.66 trillion. But Ryan, yeah, keep going on that, any relevant history for the listeners it's probably important to talk about the size comparatively to the other big card networks so despite visa and mastercard have wider distribution they um they have a lot more card holders however american express because they really focus on that um more affluent higher spending customer and they monetize that customer in a number of ways i believe amex has more revenue than both visa and mastercard but i'm gonna double check that yeah and it's because they have the vertically integrated model as well there's lots of

differences and we'll talk about uh i guess you know later in the episode how in the us american express is caught up on the the merchant distribution but international they're still far behind visa and mastercard yeah anyway why don't i hop to the history um because it's it's kind of just fun to look at so american express was founded in 1850 yes that is correct 1850 they were an express mail business in buffalo new york so the way i understand it is there was basically three different express mail um companies or offerings within buffalo and people would pay these um companies to bring their mail to new york new york city faster than you know you could by giving to someone who's taking it on horseback

or something like that um anyway they they basically had built a business around this and there were these three separate express mail businesses they were started by henry wells william fargo and john butterfield those first two may have combined later right those those first two i believe i think it was not that long after i want to say like two years after or something like that um the the consolidated company they were really saying like let's expand west let's go to you know let's go outside the eastern states and try to try to expand the business that way and the rest of the business didn't want to and so henry wells and william fargo started their own company little known uh bank known as wells fargo today um and so yeah

they did i think they may have missed out on hard to say because they've you know become a big business in themselves but um maybe missed out on a potential opportunity there anyway seven years later they they got their real start in the financial services business when they expanded into the money order business they also became a real international presence in the 1890s when they introduced the traveler's check i believe they were the originator of the traveler's check concept um and then they were kind of because they were sort of one of the monopolies at the time they were one of the companies that were hit hard by kind of the crackdown on monopolies at the time. Who was the president? Do you remember? It wasn't Woodrow Wilson at the time. There was

another. Teddy Roosevelt. There's a few different. It's hard to really track. I remember we covered that in the History of Financial Markets show. And it was almost like today where it was a hot potato that no one wanted to touch. And eventually all this stuff got passed by the Supreme Court. Yeah. And American Express kind of got broken into different parts. But that really isn't the business that it is today. I would say American Express today kind of began to take shape around the 50s. So in 1958, American Express launched their first charge card. Interesting note, shortly after Warren Buffett bought American Express for the first time in his Buffett partnership. So this is before the Berkshire Hathaway days. I think he sold it though at a

modest modest profit and this was right after there was and i i didn't jot any notes down on this but there was this salad oil scandal and so there was like somebody had basically been defrauding american express by faking their collateral and it basically there was like this i forget what it was it was like yeah it was like salad it was barrels full of what they called salad oil or something like that but under like it was diluted down and so it was basically just a bunch of water and people were like checking the inventory for collateral and ended up being some giant scam where american express kind of got ruined for it um or got hurt by it and then shortly after i believe buffett ended up taking his first kind of uh stake in

the business ended up selling it buffett did later start accumulating and brett's got to talk about this um now 20 ownership of the business i think buffett talked about that in his letter this week actually. He finished accumulating his American Express position in the 90s, I want to say. Early 90s, yes. It was about $1.3 billion invested in total, I believe. Anyways, Brett will talk about that in a second here. There were a couple of formative things that happened in the last 10 years that I think are important for investors to watch because it could happen again. In 2015, they lost costco as one of their co-branded credit partners at the time 10 of american express's

cards in circulation with costco co-branded there were concerns that this could kind of lead to catastrophe for amex um and the stock fell as much as 35 following the news so it led to a leadership change too really most likely led to the leadership change yeah and revenue as you alluded to earlier kind of collapsed a bit as well um just or slightly declined um but since that time american express's cardholder basis continue to grow they've replaced costco with other partners um delta is now a huge co-brand uh a huge partner um and so they do love this partners model i would say um there are a lot of retailers or wannabe partners uh to pair with american express so i think it's kind of a moat test here that they were able to survive um and

you know it may have been their fault i guess to lose the costco partnership but they were able to survive that and really still be uh quite a resilient business so that's that's where they're at today um i think is 130 make sure i get the number right 133 million total cards total total card members um 1.6 trillion dollars in annual network volume so it's it's a very large business it's a huge part of the really the american economy i remember that if you took their dollar volume um in gdp terms the cfo i believe said they would be the 16th largest country in the world so it's it's obviously a very large business yep and let me share the screen quick on the cards and force this is basic cards in force which is a little bit different but that's the ones that they

the core ones they do that aren't that there's just a weird difference that they segregate out some of the other ones but if we look again they've grown at three percent a year but if we hit 2015 once they lost costco they lost a good amount of the cards in force and it's stagnated for a while in 2020 they lost some people you know because of the pandemic but the last two years coming out of the pandemic, they've really regained their growth rate. And right around when the... Well, it's a few years after the new executive team took over, which I think is a good sign. We'll kind of talk about their long-term strategy going forward. And then a few other facts, or just one other fact, is that the Delta partnership accounts for 10% of their transaction

volume right now. So that's a key one to talk about or to watch. However, they do have them locked under a contract until 2029. So I guess not a concern for a long while. Okay, let's hit industry and competition. The credit card market size is kind of hard to pin down the exact number. I saw a real range of estimates from different sources. I don't know if it's too relevant here to talk about the total addressable market, because in reality, we're talking about the payments market, and it is huge. There's trillions of dollars in volume each year. That is growing, that is inflation protected, all that good stuff. Now, if we look at the card Actually, I wrote card competitors.

This would be the payment network competitors. You have Visa, who has 61.6% market share in the US, MasterCard at 26% market share in the United States, and then Discover at 2.2% market share. Amex, as we might say for American Express, has an estimated 10.5% of the total card spend in the US as of 2021, which is actually down from 15.6% in 2007. seven. Digging deeper, they're competing with the credit card issuers as well. So they're competing with people like Capital One, JPMorgan Chase with their Chase Sapphire Reserve, and then many other banks that have travel and business cards. I think an important note here, if anyone's

concerned about the volume declines versus Visa and MasterCard getting share, Amex has a much higher percent of volumes from credit cards, almost the vast majority of their business, than Visa or MasterCard who are really debit or credit card agnostic, which has been a key reason why they've lost market share because debit cards have grown faster than credit cards, which I don't think AMX is too concerned about because they're really targeting that top quartile percentage of the US market and then some of the other markets that they sell into internationally. And they don't really care if some young people like us are spending for groceries on Visa or MasterCard debit card. Now, if we look at the other competitors,

I was trying to nail down some stuff outside of the big three card networks, which I might consider, at least in the United States, to be Visa, MasterCard, and Amex. There's some people that are trying to disrupt them. I guess there would be buy now, pay later. There's crypto, there are government systems, which I will link to a source outlining India's fast paying United Payments interface. So there are some concerns about Federal Reserve type banks doing that. And there's really any other digital payments method that does not require you to connect your debit or credit card to the account. If that's not a piece of the system, then that's a competitor to Amex. What do you think, Ryan?

I have a discussion question here. What are the most legitimate threats to the big three cart networks? Because for me, outside of the government stuff, I find very little to be concerned about. i honestly had trouble coming up with any competition outside of the the big three kind of oligopoly here competing with each other yeah i mean perhaps um the government stuff as you mentioned some but you know i i feel like that rarely works um i would say there's the potential that even though it's more of a partner than a competitor um if apple pay um starts to take a lion's share of like what the way that payments are made even though it might

be an amex card or a visa card or you know mastercard you know distributed card um there might be more negotiated leverage towards apple pay if a lot of people are opting to use that as sort of their payment payment method so maybe there's some fee compression because of that but But I have a hard time seeing how any of these would get disrupted. Yeah, that is an interesting point. I think that's something to watch as well. I think from American Express, their perspective, they're hoping that there isn't kind of a big winner in the payment space. They're hoping Google Pay is successful.

They're hoping Apple Pay is successful, Venmo, Cash App, and even Zelle, I guess, as well. so they kind of have it's a more rational industry versus a winner take all that might just take a huge negotiating uh leverage there but yeah let me get to management ownership pretty simple the chairman is stefan either stefan or steven i can never remember uh squary who was named to this role in february 2018 again apologies stefan if you are listening uh his last name is sq u e r i i think it would be squary but uh it's a difficult name to pronounce he's a lifer at amex did you watch the investor day at all i did but i don't remember how they pronounced it he's a new yorker though he's a big-time new yorker i liked his accent he

he made just like the strangest joke at the start and everyone it was like it's like this rehearsed joke that's like you guys all look you guys all look like you put on weight since we last spoke or something like that yeah it was a tough it either way the investor day i think went well I liked it, but the start out, they start out low, but he is a lifer at Amex. He joined the company in 1985. So they like to hire from within. They got a good mix of people in their executive ranks that have worked at the business for multiple decades and some outsiders that brought in like the chief technology officer and a few other people that they're trying to modernize and catch up with Visa and MasterCard. If you look at the board of directors,

it's fairly standard for what I might categorize as a quote unquote Dow Jones company, which they in the dow uh with plenty of independent directors from a variety of industries lots of seats and you know they pay them a few hundred thousand dollars each year with the size of the company the board of directors pay is not a concern at all really sound no red flags there what you have anything to add there ryan not only are they a dow jones company they were in the original dow 30. so i don't know how many companies are left from the original dow 30 but they're still i think they could be the only one left uh you know if you're gonna base your investments off the lindia effect this is this is your number one holding because they have stick around for a long time um but yeah

executive compensation back to the you know management here they have three criteria of course it's classic compensation consultant uh stuff here you have the base salary annual cash bonuses and long-term performance stock awards total exact compensation was 77.5 million in 2021 It's a really not a big deal, about 1% of 2022 pre-tax income. So as a proportion to the size of this business, not a big concern here. The annual bonuses are based on a wide variety of metrics like revenue growth, earnings per share, net promoter scores, and something that I was thinking about for at least 10 minutes after reading it, where they said, and this is the exact quote, firing up the core engine, which makes no sense to me. Luckily, 50% of the waiting

are to the key financial metrics. I don't think that was a huge deal. I think they're just trying to start up some ESG stuff to get those types of things in line, which it's not a huge concern, but watch out if they do all their incentives at 50% on firing up the core engine, quote unquote, which again, I have no idea what that means. Maybe you can get concerned, but right now, it looks like their incentives are in line with shareholders. And speaking of which, I really liked their long-term stock awards. They're based on three-year average return on equity, which I think is relevant for their company. And then total shareholder return or TSR versus peer group companies, again, on a three-year basis. So that was good. I left out

a quote for the newsletter, which again, subscribe to get in conjunction with this episode on how that's all calculated out. Ownership, like Ryan mentioned, Berkshire Hathaway owns 20%. Then we vanguard blackrock with their standard six percent stakes and then if we look at all directors executive officers they own less than one percent so yeah no founders here they're all dead um long i think that's it long gone yeah does berkshire owning it matter to you at all yes and no i think it's good from a financials perspective as a financials company with credit exposure it's good that one of the best in that category ever has is looking at them closely as one of their largest holdings but on the other hand from a say it's not too big of a deal because

they're not taking activist stakes really anymore um he's not on the board it's not he's they're not in that part of their career you know as a company so and he said that amx is a never sell for them. So I don't think it matters too much because maybe management at Amex kind of has that on their shoulder, kind of the Buffett, I don't want to call him the devil, but like the person that they always know is there, they feel is there as someone who's like, hey, if we make this decision, is our largest shareholder going to be pissed? Possibly that's happening. But yeah, I don't know if I would buy or sell based solely on whether Buffett owns this he's owned it for 30 years it's not like where he's buying they're buying today yeah that's true

i just yeah i do think it sometimes influences management's like decision making or just like you know them thinking like well we do we should be cognizant of our largest shareholder here it would probably prevent them from being maybe too self-serving in in some ways but uh maybe they just don't at this point i think he's so passive in his ownership that it probably doesn't matter that much um let's talk about earnings though kind of just go kind of to paint a financial picture of what this business looks like they do 51 billion dollars in annual revenue or they just reported their 10k so um in 2022 they did 51 billion dollars in total revenue that was up 25 percent year over year i already kind of uh described what the revenue mix is like but

most of that is merchant fees they did have a big boost in the service fees from the travel commissions as well um but they have 41 billion dollars in total expenses with the largest part of that being card member rewards and then the rest of the business is kind of what you think it would be it's very um you know they they require tech talent they require a bunch of corporate employees um and then they got to pay out a big chunk of expenses um to those people And there was actually an interesting quote. During the CFO made a presentation at, it was like the Bank of America Consumer Finance Conference or something like that. And they mentioned, they were like, you know, what are you thinking about kind of recessionary fears? How would that impact your business? We're seeing a lot of layoffs right now. And the CFO basically said, like, first of all, to the people being laid off, we'll gladly hire you. We recommend applying here because he said, like, do you have any idea how hard it is to get good tech talent these days?

And so I thought that was kind of an interesting point that he they are still kind of trying to, even though it's potentially a recession or a slowdown, they're kind of attacking the opportunity they see in front of them. And as for earnings here, they generate about $10 billion in pre-tax income or 20% pre-tax margins, which they've averaged about 20% pre-tax margins since the 90s. So it's really consistent there. They really invest back into the business. They haven't juiced margins by any means. It seems like they try to keep it around 20%. percent um and they pay out about this year they paid out five billion dollars to repurchases and

dividends um or about 70 percent of their net income typically uh and that's that's more heavily weighted towards repurchases um but they do uh they do return a lot of capital to shareholders and then just in terms of like qualitative or less less financial metrics um 133 million total cards enforced, that's growing about 3% annually over the last 10 years. So it's not rapid growth in the card member base. They're pretty choosy about who they let in to be an Amex card member that you have to have a certain credit score in order to be a card member with Amex. And then there's 1.6 trillion in annual network volume. And so the actual volume across Amex cards has grown by 6% annually over the last 10 years. So the card members are actually spending more over

time um but but solid steady growth really over the last i want to say 40 years or so so um not not really one that you'd uh invest in i think based on like a single year's earnings or numbers or anything like that you're kind of trying to predict the quality of the business over time yeah yeah and two things to add there one when you're looking at net income make sure to look at each year their net uh charge off so their net i think that's what they describe it right basically what they're allocating or unallocating for credit losses each year, because that can make things a little bit cyclical. So I like to look at their net income and then also their earnings minus the net charge-offs to kind of get the core stuff that might be a non-cash charge that

changes each year. And then second, Ryan mentioned the employee efficiency, their revenue per employee since 2005 has grown at a 4% rate. It's kind of stagnated in recent years, but I think that's somewhat because they're still getting a bit of a headwind from the pandemic. And there were a few expenses that kind of increased there. So I'd hope it trend higher over time, but yes, very efficient on that front. And maybe with all the layouts of the big tech companies that are sexier than Amex, they could get some spillover and get some good talent over the next couple of years. And the charge-offs thing you mentioned, I'll talk about that here in the balance sheet, but it's that's included in their net revenue figure basically through um when they'll report

interest revenue and then they'll do the interest income or sorry the uh uh interest expenses um and basically will deduce to a uh net interest income figure and they'll tack that onto their revenue from the other line items but um when we look at kind of the asset side of the balance sheet 34 billion dollars basically in cash and interest-bearing deposits they just kind of invest the majority of that in short-term uh investment areas um and then they have 57 billion dollars in card member receivables most of that will will be received they do write off some of that um if you know the inch if they feel like a certain percentage of of those receivables aren't going to come in um and so the net write-offs jumped from 0.2 percent in 2021 to 0.8 percent in 2022

still much smaller than um peers in the space um but it's worth noting that that may uh begin to affect some of that interest income uh that that's a key it's a key it's a key number to watch for sure especially over the next few years if we're worried about a kind of bullwhip of economy recession and all that good stuff yeah and then they have this so that's the card member receivables so that's just like what they've uh credit they've allotted to their customers and then there's 108 billion dollars in loans to card members as well the percentage of loans that are 30 days past due are at about one percent uh in 2022 the year before they were 0.7 and in 2020 they were one percent again so they really haven't seen that much of a fluctuation due to the higher interest

rates and they actually um they kind of talked about they talked a lot about the lending quality with the business these are more financially savvy customers that pay back that are generally more credit worthy and so they have much lower um delinquencies than a lot of the other credit providers. And then on top of it, I believe on carried balances, they have higher interest rates than a lot of other customers or than a lot of other credit providers. And so people tend to pay off Amex first when they're trying to get back within kind of the credit borrowing or trying to get, I guess, trying to pay off their loans or credit. They want to pay off Amex first because the higher interest rates and because maybe they want to make sure that they maintain being an amex

member because of all the social signaling it provides which we'll talk about a second liabilities basically 43 billion dollars in long-term debt outstanding the majority of that is fixed rate senior notes all pretty reasonable interest rates 2.8 to 4 percent range um and the maturities date all the way out to 2042. the rest is kind of a mix of floating rate debt that i didn't see any any rates that were too crazy um and i think part of that is just because they have like different subsidiaries across the business and so they they have to borrow in certain jurisdictions or stuff like that and so they they have some floating rate debt but the majority here is just low cost um fixed rate so really you're looking at right around nine ten billion dollars

in net debt uh for a business that generates 10 billion at least in pre-tax income uh this this is not too much leverage at all yeah there's a few different ways you can calculate the net get debt because it just depends on how you do it because the way i did it and i can't honestly can't remember what i used for the calculation i had net debt of 5.4 billion but really not a huge difference if we look at valuation keep it quick market cap 130 billion dollars ev is going to be slightly higher and the only really metric i would think is relevant for amex is going to be enterprise value to earnings. And right now, we're at exactly 18, pretty close to the market average, quite a little bit below. And it's right around their historical PE or EV to earnings.

And if we flip that around, their earnings yield, I guess, on this enterprise value, which will be the same as on their market cap as well, is about 5.6%. So you're getting that sort of yield on the stock each year. We'll talk about what that implies for what you need to expect if you want your returns to be above 10% going forward and stuff like that. But yeah, that's kind of how I'd like to look at it because for this company, a lot of it is part of the capital return. A big part of it is the capital returns. So this is how they're funding their dividend. This is how they're funding their buybacks. But yeah. All right. Let's move to the fun stuff anecdotal evidence ryan i guess this really matters here sort of it's not our

opinion isn't the sole arbiter of what their brand is but what are your thoughts on the brand maybe we can give the listeners some context of what people in their 20s think of amex yeah i think this is regarded as a premium brand it's considered luxury a lot of it is just social signaling that you know you want to be perceived as wealthy so you pull out your uh amex card and the amex cards i will say they are uh quite literally built different they like are a different material i can't tell what i don't know what it is but it's it's heavier it kind of makes it it's tight well the black card is uh the black card is titanium so yeah okay well the uh i don't know apparently it's it's it's a flex as kind of people say today um and it it signals that you

you know you pay 700 a year for your credit card you can spend a lot that kind of thing um i think a lot of people also like the idea of sitting at these lounges these really kind of nice looking lounges at airports so they're willing to pay out to be kind of a member there um i've seen some bigger for the young people too yeah but i've seen like pictures where the lines are so long at these lounges and like like what's the point you got to get there like five hours early for your flight just to like sit at that lounge but yeah they got to restrict it more let's get it only to the the top card members but maybe they're being too uh they're being too lenient on who they allow to have to be a platinum card number but that's like a good and a bad thing

because it means they're getting a lot of new card members, but you don't want to ruin that exclusivity feel. Yeah. But I guess just anecdotally, yeah, people will go a long ways to signal their wealth and Amex is one way to do that. And I think it certainly still maintains that premium brand that it's known for. And also, I used to be worried that with the higher fees or whatever, merchants would be less inclined to accept it. But seeing that stat of 99% of merchants in the US accepting it. I think this is just really good. It's really well received. The stigma or the reputation of catering to luxury customers, I think, fits. It's probably better for merchants to accept it because they know that they can attract a more affluent base

will probably come as as return customers too yeah i think when looking at this company there are two narratives out there that i think are actually misguided uh i was throwing out some tweets as well to see what people think i think there was a lot of them who i would have agreed with them before researching it um but i think they're wrong is one the say brand value or how much young people like mx they there's kind of a narrative that that's deteriorating i don't really think that's true and if it is it's very very small compared to the other generations almost all their new card members now are from millennial and gen z and then second they talk about the like people have this narrative that you can't like you can't just have amex and maybe that was

true 10 years ago but the the new management team has worked to fix that and then as ryan mentioned they have 99 coverage now in the united states so i think that's two positives where the business quality potentially could have changed over the last five years with this new executive team that is um executed really well but let's move to future growth opportunities ryan what do you think here it's pretty simple one get more card volume but i guess what's one way you have for them to do that yeah so i guess this is maybe not even the card volume necessarily it's just maintaining more money on their platform and so this is converting more card holders to american express bank accounts they've done this they even the cfo basically said we could have

done better with this to try to get people into the high yield savings accounts and they were late they were very late to this right yeah well i don't think they officially got a bank charter until 2008 so they didn't officially become a bank until 2008 so maybe they were just late because of that but um they didn't launch their first all digital checking account until this year um and so they are still in the process of converting a lot of those um they want more card members to be high yield savings accounts members as well um and they the cfo kind of discussed this for i guess two minutes or so during that recent conference he said there is significant overlap between those who have a card and those who have a high yield savings account

but not complete overlap he said one of the things we probably under executed on for many years was mining both ways the power of the overlap um so maybe even attracting high yield savings account first and then cross-selling the cards um the other thing i guess worth mentioning is the uh this they are trying to focus on lending more so they've really done a good job boosting spending but they want to boost lending this is something they talked a lot about at the investor day having more customer funds on the platform will allow them to lend more um well easier easier yeah sorry it's lower cost uh so it'll it'll allow them to potentially uh a lower cost of funds will allow them to lend with a larger margin of safety yeah i really like the

fact that they're trying to launch these bank accounts and i think look it's not bank accounts are sticky it might be hard for people to switch over but if someone can just open a bank account with American Express, that seems like a much higher, maybe we'll call it ARPU, an average revenue per customer or whatever earnings they get or the lifetime value of that customer seems much, much higher. And if I was someone who was a younger wealthy person and I could open up an account with American Express, or if I was a family and I had the ability to bank through American Express, if I was to say 1% are family and wanted all that access and give the cards to kids and you get them in that funnel i mean that seems like a much more i guess i'm trying to use

the word robust but i'll use it here a much more robust uh system that they can add on here which is with this product or i mean not just one product but all the banking products they're trying to push onto more customers and the cfo said they mentioned or he mentioned that uh they have now consolidated the high yield savings like group into or under the card the the card group And so apparently there was a disconnect between the two. They tried to make the internal changes to get them better connected. But I think that should be a pretty easy cross sell. Yeah. All right. I'll hit mine.

We do, as a caveat here, have a soft rule that we cannot use international growth as a future growth opportunity. But with Amex, I'm going to use a specific international growth opportunity that I think is going to be fine, where I think it can be a core driver of them getting to merchant parity with Visa or MasterCard and that is simply investing in their sales outreach in more international countries. They've been doing this, but basically just continuing what they're doing and expanding from, how would I want to say, just the United States, Japan, Australia, and the United Kingdom to trying to becoming a fully global payments network like Visa and MasterCard. when the new management team took over in about the 2017, 2018 period, they decided to target a

few international markets as they thought they were spread too thin. And they really wanted to catch up in the United States and some of these other areas that their core customers, or they want to have merchants be used there. But I think over the next 10 years, they can eventually expand to all relevant countries outside of the United States, which would be places like, well, they're investing a lot in China, I guess that might be a downside for me. But places like India, places like other places in Europe that might not be the big countries that people think about. This could be the Caribbean. They mentioned that as well. They got merchant, I don't want to say parity, but they invested a lot in the merchant base in the Caribbean where a lot of their

customers vacation. Also in Central America, South America, where their customers might vacation. This will not only increase the value proposition for their domestic customers, which by domestic, In this case, I mean, they're United States customers, but also the quote-unquote world traveler customer that Amex targets in other wealthy countries. So I think it just would be really great for their whole system too. And basically, it'll be harder for them to do it, but they can get to at least close enough for their client base to parity with these in MasterCard. It's just going to take them probably a decade, if not longer. What are your thoughts on that part, Ryan? Well, I don't think they'll ever reach the distribution.

of visa and mastercard just because it's that's what these are going after they have an inherent advantage yes visa and mastercard do but it's good enough for their customer base yeah i would say that i i wish i saw a figure i'm not sure how what the merchant acceptance is abroad but i'm curious i feel like that's probably one of the biggest growth levers is acceptance is good yeah they gave some good numbers on the investor day it's lower than the united states however in some countries they gave and maybe they're just showing the ones that did well like france they gave out some numbers on how they you know their nps their net promoter scores have risen their merchants um i don't think is that parity with visa and mastercard but is rising

so they're making progress there and i think they can invest a lot into that over time and and see good returns from customer retention and you know more card volume as they say the more you know people spend the more they earn okay uh highlights and lowlights ryan what do you like dislike about this business seems like we're a little bit in the same boat here uh lots of highlights and low and not very many low lights which is is fun to see it's exciting yeah there's a lot to like um so i having the diverse revenue streams i like that because it just makes them a little more resilient and sort of a difficult environment or financial environment so like um you know having the spend centric model this exposes them basically the lower credit risk than other

financial institutions because they're not just relying on that net interest income like a lot of banks um and so i really like that um and they i mean also like theoretically like if there's and this is another highlight for me is if interest rates are rising that likely means inflation is high which they are a direct beneficiary of that if the cost of goods goes up for all the for customers at all these merchant locations plane tickets that's a key one it's they benefit i mean they directly benefit they take a percentage of that transaction um and so revenue will probably outpace cost growth in those environments so That's a positive for me. The other one is the premium brand. I think there's a lot of benefits

to attracting a more affluent customer base. One, they carry less credit risk, but also their spending is more resilient in downturns. They're probably, I guess, less levered to a consumer slowdown than maybe some of the other card issuers. and then low lights i i honestly had a hard time finding any um i would have i would if i didn't see the merchant acceptance growth in the last three years i probably would have said that like maybe they're um gouging merchants too much or maybe the card fees are too high but they've been able to consistently grow merchant acceptance and grow card members so that kind of puts both my worries to rest the international distribution or disadvantage

versus Visa and MasterCard, you've already talked about it. That's probably the only potential low light. But I mean, this is a very, especially domestically, it is a phenomenal and resilient business. Yeah. And I think what's interesting is that in 2017, 2018, right after they lost the Costco partnership, right before this new executive team came into their roles,

I think we would have had much more low lights, many more low lights. but they kind of fixed a lot of those over the last few years. So it's, I think, again, this is what's interesting is that the narrative out there among the investing community might be different than what's happening at the, you know, with this business. And that could present an opportunity here.

Not we don't do buy or sell recommendations on here, but again, I think that's kind of, that kind of sets off the, the alarm for me that, Hey, there might be something that we're seeing here that is different than the narrative in the uh just kind of wall street or investors in general yeah and i'll i'll add you know you talked about the new management team i liked the cfo a lot i liked what he had to say i liked all the people that spoke at the investor day i like the ceo even though yeah that weird joke i'm not gonna hold it against him i think they've all done a really good job since they've

been there yeah and the track record's there they they really yeah the pandemic was a bit of a hiccup for everyone. But 2021, 2022, they showed that the investments they made are working. They're adding all these cards, all that good stuff. But yeah, let me get to my highlights. I think a big one, the biggest one is the virtual distribution parity with Visa and MasterCard in the United States now. I think this means the industry has achieved oligopoly status. And I guess it was there really, but it's further solidified that each year and year out where Discover is. Maybe they won't ever go away, but Discover will probably be gone and there'll just be these big three. And these big three can act more rationally, at least on the payment network

side. Yeah, they're going to face a lot more competition from credit card issuers because Visa and MasterCard, one as many as possible. But I like this because one, there's high barriers to entry. I don't think anyone could enter. No one's going to become one of the big three here. It's just impossible. It's just how much market share are they going to lose, gain market share versus Visa and MasterCard. Second highlight, I think the international expansion strategy that they fixed starting in 2018 seems very rational and achievable. They started working through important cities for their customers or their core customers, which would be something like maybe Tokyo, Singapore, Sydney, before moving to all the

relevant regions eventually. What I really like about this is they can invest a lot into this expansion and will likely get durable returns for many years because payments are pretty standard across the world. The wealthy people spend on the same thing. So you can really connect the ecosystem together. And I also think what's key about getting to international parity or working towards as close as they can get with international parity is they can have a wider moat five years from now if they execute on that even further, which is a key indicator that Buffett likes to ask or a key question that buffa likes to ask and i guess sometimes we like to ask as well uh third one the cards and force additions have been strong close to any of the costco partnership

um and they've skewed towards the gen z and millennial customers which are going to have higher lifetime values they're going to be around for maybe 30 40 years as amex customers compared to a boomer gen z or excuse me boomer gen x who might be you know 20 years or something like that That's the big one. During the investor day, they said the millennial Gen Z customers, I'm not sure how they're measuring that specifically, like what the age is, have 18 years of greater lifetime value than their older customers or expected lifetime value than their older customers. So yeah, that's another big highlight.

And then my last highlight, which we haven't talked about much, is the capital allocation strategy. seems rational and importantly consistent uh shares outstanding have declined by almost three percent a year since 2017 and they've had this buyback strategy and for much longer than that they are share cannibal and that's a reason why the buffett stake has gone from i think like 10 to 20 without them touching their uh without buying more shares which is great that's got to be a great feeling to have especially when it's such a big company and his dividend is like 50 a year a 50 yield on this cost basis here's a good question do you think now this might indicate

this might spoil that we're a little bit uh optimistic about this business but do you think 10 years from now they'll look at amex in a better light as the berkshire investment than coca-cola yeah i think that eventually it might even be getting there yeah like at this point just because the stagnation yeah the early years of the coca-cola investment like skew like helping more yeah it was so good so quickly yeah yeah but the i guess this do you think american express will have a wider or be a better business in five years than it is today i would bet yes and it is because of the international investments they're making because if they make those and they're successful and adding merchants again they're never going to

catch fees in mastercard internationally but i think if they get closer and they're in the core you know big travel areas that their wealthy clients want to go to yeah i think it'll be wider for sure what do you think yeah i do i mean they they at this point they benefit from their own scale right more merchants want to accept globally because of all the card members that american express has so i mean that's uh going to be revenue added on to the business the yeah i could very much see like this business i mean the success feeds on itself obviously there's a little bit of like a cold start problem internationally in some of the markets but um they've got the reputation And I think they've got like the cardholder base that it's attractive for

merchants to accept this as a solution everywhere. Yeah. All right. Let's hit my low lights before we close things out. I think Amex does have a inherent distribution disadvantage versus Visa and MasterCard. Like we talked about just now, they're working hard to fix this, but it is probable or possible that they're never going to be able to catch up because they have to work really, really hard or maybe not really hard, but they have to put in a lot of work to have the distribution where Visa and

MasterCard kind of just sit there and let merchants and customers come to them just because they aren't the card issue or they are the payment network. So they're going to have an advantage there. But American Express, there's other positives because of the vertical integration. Other low light I found, and again, I couldn't really find any large ones or big kind of red flags, is the reliance on large partners, especially Delta Airlines. Delta Airlines is 10% of their transaction volume. And that is not payments through for Delta Airlines flights or any Delta Airlines products.

That is through the Delta Airlines card. So they're probably getting poor unit economics on that, which I guess is fine. It's probably not going to change. And the contract is through 2029. But they have to use that to drive volumes, drive customer acquisition. And I just wonder if that relationship can turn into a Costco one over time. We'll see. We'll see.

i think they probably have a good relationship but i would say that partnership is more like uh disposable than costco would be like yeah you know there are probably a lot of other airlines that would be buying for that opportunity yeah yeah you may be right and i think delta gets a big benefit from that as well because then they get seen as maybe if it's just ever so slightly the more premium brand versus united or american or what's the other big one southwest because you want amex is not going to do a southwest card no i agree all right bull case for you ryan what do you think uh i mean the bull case is uh just more of the same really um i think interest expenses are probably elevated right now just due to the the percentage of the the rapid increase in rates as

opposed to like the gradual increase in rate so i think if interest expenses revert as a percentage of interest revenue um it's going to be higher net interest income so you'll have normalizing interest income potentially uh cardholder base continues to grow at three percent a year card fees continue to gradually increase they've shown a really strong pricing power on the card fees. And then the global merchant acceptance increases. I think that's a recipe for 10% plus top-line growth. And I see no reason why they wouldn't be able to sustain that 20% margin that they've had. Yeah, that's a good point. And I tend to agree with you. What Ryan is mentioning is also what management is outlining. They said they're outlining 10% plus revenue growth from

2024 onward. And that will lead just since their buyback program, since a little bit of margin expansion, even higher earnings per share growth, probably in between 10% and 15% is a reasonable guess. But, and I'm looking at a stratosphere chart here for any listener only, their net income per share has only compounded at 7% since 2005. So you have to bet on a little bit of acceleration here. And yeah, since the new management team has taken over, if you can exclude the pandemic period. They have shown a better success on growing that earnings per share number and that's showing up as well in the card additions. But historically, they've been a lower growth company. So I think that's kind of the bear case maybe to add on as well. But I'll talk

about mine. It's similar. It's just management hits on the targets that they set out for where you're trading at today an EV to earnings of 18. At those prices, it kind of indicates you need a durable top line growth, but not too high. Kind of in order to achieve maybe annual returns of 10% plus or more on the stock going forward. Management's guiding to 10% revenue growth from 2020 or four onwards. Like I said, you add in the margin expansion,

you add on the share repurchases, you add on the dividends. And I think if they hit that top line of 10% and maybe even a little less, maybe if it's seven to 8%, the stock can still do well going forward. But let's move to bear case. Ryan, what do you have here?

the bare case for me is that we have some sort of a slowing spending environment some sort of recession i think they'd be better positioned than peers in that but it still probably would create low enough earnings growth that you wouldn't get an attractive return from here over the next five years um i know there'd be a lot of companies that would give poor returns in that sort of environment. But I think they'd be more hurt in terms of new card member acquisitions in a tough consumer environment because of the fees on becoming a card member. I think people would be more cost conscious. So maybe they wouldn't lose members, but the new members might go for the cheaper option in those sort of scenarios. Yeah. Here's an example just for what

you know just an and not an antidote a potential analogy is you know say there's less people at big tech making three hundred thousand dollars a year that could transition to less people wanting annex cards or less people having the uh spending habits where it makes sense to have an annex card yeah and i mean they also have a lock-in with a lot of enterprise businesses so those enterprise businesses shrink their workforce um there's you know less cards passed down to the uh employees that's uh that's gonna be headwind to car to the card member base yeah we didn't even talk about that today is the business side of things i mean it's too long for this episode but if you're interested in it they do have some potentially promising stuff over on their their

business uh stuff with the the business cards they offer the members some of the other you know working capital stuff they've been talking about as well with some of their acquisitions i would recommend watching their investor day to get more information on that. But this show is going to go too long. If we go into that, it'll take 10 to 15 minutes. My bear case is going to be really two things that I'm worried about is one, increased customer acquisition costs due to the proliferation of Visa and MasterCard back cards. So say, for example, they are trying to renew a partnership with someone for these travel and entertainment partnerships or the travel and entertainment linked cards i think these in mastercard could potentially undercut them uh as they have in the

past and that could lead to worse unit economics but on the flip side with this being an oligopoly with no new entrants coming in i doubt this is going to happen to an extent where it really hurts american express but you know they lost they lost the costco partnership to the to the Visa and Citi, whatever, team. So it could happen and that could hurt them. And then I also, I think the bigger concern for me is that they potentially are over-earning right now, where last time, or excuse me, last year, 2022, there was a big bump in spending that couldn't potentially not hold up in 2023 and 2024. For reference in the newsletter, I would look at the changes in the consumer savings rate that I linked to here. We saw in 2020, consumer savings rates skyrocketed

and that, by definition, will lead to lower card volumes for someone like American Express. However, in 2022, we've seen it really, it went down to an all-time low where people are spending through all this XX savings. And then to start 2023, we've kind of seen it normalized back to that 5% to 10% range that we've seen since the great financial crisis. I wonder if that will turn into a short-term headwind for American Express in 2023. It doesn't mean the business is screwed long-term, but it might mean they over-earned in 2022 specifically. Any thoughts on that, Ryan, before we close out? Yeah. I mean, it's a possibility, especially with the boom in travel spending and then being sort of tied to that. If there's any

sort of reversion there, then they could be more disproportionately impacted than other card networks. Yeah. All right. More or less interested before we end here. Yeah, I'm more interested. This feels like the kind of business that the longer I invest, the more I realize, why don't I just own something like this, where it's very durable, very predictable, rational management that returns capital to shareholders. It might not seem like the most asymmetric opportunity, or maybe it doesn't seem like there's like tremendous upside, but it's, it's far more predictable. I think that a lot of businesses out there, maybe just the most, uh, important thing to understand here is it was in the original Dow 30 and it's in the Dow today. Like it's good.

It's going to be around for a long time. Yep. And they've probably had some bad management teams along with it. So, and there's a reason Buffett owns it in his kind of permanent portfolio. I'm in the same camp. I'm more interested. This might go into the category of stocks I'd rather buy at a PE below 15 because I'm worried about that long-term earnings growth. And I want that margin of safety of, hey, if they don't grow that much, we could still get some good returns due to their capital allocation. But I'm still more interested in this business. Definitely going

on the watch list. I think it's high quality. I think the new management team has done really well and can widen that moat over the next five years, just as they did over the last five. So yeah, I'm more interested. All right, let's wrap things up. We're talking next week, Nelnet, which is a unique financials company that we own in the Arch Capital Investors Fund. So we'll be doing it under that format.

It'll be coming out Tuesday, same time. And then the month after, we're actually going to be covering dating apps. So we're going to be covering Match Group, Bumble. What's the other one, Ryan? I forget the name, but there's two other small ones we're going to be covering as well.

So we'll cover some small cap ones and then the two giant players. and then as a reminder oh yeah you have ryan or it might be great it's grinder excuse me grinder well there's another one too um that's like a smaller one um it's spark networks good name network's grinder bumble match group all right yeah that'll be fun in march uh just as a little tease there as a reminder if you're a regular listener to the not so deep dive episode subscribe to our free newsletter and get our show notes and charts with each episode the link will will be in the show notes, or you can search Shit Chat Money on Substack. If you like watching

these episodes, you can do so either on YouTube or Spotify, but you can also do audio only. We try to make it so you can listen enjoyably in audio format or in video format. And also, if you enjoy these episodes, give us a review on either Spotify or Apple Podcasts. We are not financial advisors. Anything we say on the show is not formal advice or recommendation. We are general partners at Arch Capital and clients may hold security disgust in this podcast. thank you all for listening or watching we'll see you next time