$52.9 billion. That's the total revenues
net of interest expense Amex made in 2022. But despite its impressive
earnings, Amex is far from dominating the credit card
industry. Its domestic payment volume
is far behind that of Visa and MasterCard, and it lags
behind Discover based on the number of cards in
circulation. It's a difficult business
for American Express to be in, given the threats posed
by Visa and MasterCard. What they've leaned into are
people who use the card a lot, spend a lot of money,
and pay it off, and they're willing to cater to that
crowd by giving them premium perks, whether that's at
the airport or things they can use every day. Whether that's a Walmart
plus membership or Uber cash or things that keep you
using that card, keep it at the top of your wallet. Armed with impressive
rewards and a loyal customer base, Amex has achieved
impressive growth. The company's revenue has
increased over 32% since 2017 and shares of the
company have shown resilience and growth in a
tumultuous market. Amex, I would think of them
as a bit more of a what we call a quality compounder,
like a very steady, stable business. Growing revenues,
high single-digit to 10% and then they get a little bit
of operating leverage on top of that. They grow earnings
in the low double digits. They've learned a lot
through COVID. They've diversified their
business model. They've sharpened their
pencils on what matters to their customers. And it's
really showing and they're coming back strong. So what is the secret to
Amex's success and where is it headed next? American Express began as a
freight forwarding company in 1850, transporting
various goods across a rapidly expanding nation. It wasn't until the late
19th century that it began its transformation into a
payments company. It began to introduce
financial products and travel services. Then, in the 1950s,
following its high success from traveler checks, it
introduced its first charge card to offer customers a
more convenient way to pay. Where the brand truly begins
as we know it today, in my opinion. You know, they've
had multiple products come out, the gold card, the
platinum card, and really focusing on the consumer
and the corporate card business. What sets Amex apart from
the rest of the industry is the way in which their
network operates. Most credit cards from
companies like Visa and MasterCard function in
what's called an open-loop system. When a cardholder
uses the card in their network to make a purchase
from a merchant, they generate revenue by
relaying that information from the issuers, usually
the banks that have issued the cards to the acquirers,
or the merchant's Bank. Amex, on the other hand,
operates in a closed-loop system where it functions as
the issuer, the acquirer, and the network combined. Amex is different from Visa
and MasterCard because Amex is a lender. Visa and MasterCard are
merely card networks, so they process transactions,
but they're not actually issuing credit. American Express is both. They are a lender of credit
and also a card network, a processor of transactions. That really enables them to
see exactly what their customers are spending down
to the item and have all that extra data where they
can then advertise or target different reward spans
across that. That's going to be very
different than what Visa and MasterCard can see, which
would be just really total dollar amounts. It allows them to tailor
some of those deals, especially on the merchant
side. If there's a reason why
they want a specific merchant's business, they
can change their normal terms in order to fit that
situation. They don't have to worry
about a bank being upset about what those terms
are, whereas Visa and MasterCard would. This closed-loop system also
allows Amex to earn money from interest, unlike Visa
and MasterCard. The company generated about
$9.9 billion in net interest income in 2022. It's advantageous to be
diversified. So they get paid any time a
transaction is processed and then there are also other
levers like people who pay annual fees or carry debt
or other things that incur charges. But interest income is just
the tip of the iceberg when it comes to Amex's total
revenue. Discount revenues, or fees
charged to merchants that accept its cards brought in
more than $30 billion in 2022, contributing to more
than 58% of Amex's total revenue net of interest
expense for that year. They charge a premium to
their merchants to take their cards, and the
merchants are willing to pay that premium because
American Express is bringing them the most affluent,
biggest spenders. They make the discount
revenue off of the swiping and so they charge the
merchants a certain discount rate, two and a half or so,
it depends. This can vary by merchant
size, actually, but a lot of their revenue, unlike their
competitors, is coming from this swipe fee versus net
interest income. Because of its reliance on
discount fees, big spenders are Amex's most important
asset. Recent reports claim that
Amex card members spend, on average three times as much
annually as those who aren't members. Amex targets these
affluent cardholders through a spend-centric model that
focuses on generating revenues primarily by
driving spending on its cards. That's where rewards
come in. In just 2022, Amex spent
almost $17 billion providing services and rewards to its
card members. When they talk about a
spend-centric model. They're really talking
about being your go-to card. And I think a really good
example of this is the Amex Platinum Card, one of their
flagship premium products. On the face of it, this is
a travel card and it has a lot of travel benefits with
rewards and airport lounges and all that fun stuff. But you can also get a free
Walmart plus membership and you can get a whole bunch
of other everyday kind of credits. They're trying to
make this a go-to, every day, not just something
that you pull out a few times a year when you're
traveling. That high spend-centric
model is the reason why they can provide such strong
rewards that they do and why the customers are willing
to pay those higher annual fees than for other cards
because they're getting the benefits of the spend and
the rewards. Because the people that are
spending are actually making this up in their spend
behavior. Having a closed-loop system
means how much the cardholder spends is
usually more important than the number of transactions
made. Amex also utilizes the
immense information gathered through its closed-loop
system to create offers that attract and retain
customers. A lot of the tricky part
about rewards programs in kind of big, kind of more
mainstream cards is that the rewards are a little bit of
like ad hoc, like they might have very cool, interesting
rewards, but they might not be things that you as a
consumer value. In American Express's case
because of that closed-loop dynamic and because they
know you and they know the merchant, they can create
rewards that feel to you as the consumer, like this
program was custom designed for me. Like they can go
out and recruit all of the top hotels and all of the
top restaurants and have specialized offers and
specialized rewards and stuff to bring consumers,
the affluent consumers, to those hotels, to those
restaurants. And everyone sees benefits from their
role in the middle of connecting those dots. Having an affluent customer
base also gives the bonus advantage of decreased
credit risk. Delinquency rates for Amex
have remained substantially lower compared to other
major issuing banks. Credit losses through the
cycle will move really closely with unemployment,
as you would expect. If you think about the
changes in unemployment, they roughly go up between
1.7 times and 2.25 times in a recession, and the prime
credit card issuer will see roughly that same sort of
increase in credit losses over that time frame,
whereas an American Express could actually see a little
bit less than that. So if it was to go up two
times, you might see American Express go up 1.8
times. And so that makes a big
difference as far as the cyclicality of the
business, the overall risk to earnings, and returns. It's really one of the
reasons why investors kind of focus on this stock in a
downturn. It's considered a safety
play and that's why we're outperformed with the stock
today. In recent years, Amex has
begun to diversify its customers further, mainly
targeting millennials and underbanked Americans. I really think that Amex is
doing a good job winning over younger customers as
well. They've talked about how
about 60% of their new card acquisitions are Gen Z and
Millennials, and I think they've done some creative
things there with experiences, whether it's
travel or dining or exclusive concerts, like
they did one with Jack Harlow. And, you know,
they're just trying to reach a younger audience that
will be the leaders and heavy spenders of tomorrow. Amex has also made
meaningful investments in scaling and improving its
technology, allowing its offerings to be more
competitive against the rise of alternative premium
cards. They continue to make
progress abroad. They were actually the
first US based credit card issuer to win approval in
China, and they're partnering with local
brands there to really tap into that increasingly
affluent consumer audience. In Europe, this is like
France, Germany, credit card adoption, both by affluent
consumers and by small businesses, is much lower,
much lower than it is, say, in the US, the UK and
Australia, where it's quite high. And so there's a huge
amount of just growth opportunity. I think increasingly they're
also tech companies in a way that whether that's the
apps and the web experiences that they provide or all of
the data that they're gathering. You know, some
people say that a concept like buy now, pay later
could be a big threat to the Amex model. They actually were the
first traditional credit card issuer to unveil their
version of that. A few years ago, they came
out with Amex Pay It Plan It, which I think again
speaks to offering something for everybody. The biggest threat for Amex
is the competition within the credit card industry. To me, the biggest weakness
or danger for American Express really is that
marketplace power of Visa and MasterCard and what
they may decide to do with it, which may or may not be
anything that American Express can control. The value that they are able
to offer from the closed-loop model is
distinctive and unique. But as things like data
analytics and AI get better and the whole
process of issuing cards and managing card programs
becomes more digitized, as their technology advances,
those open-loop card programs can better
replicate what American Express is able to do
uniquely. So they can run better
analytics to understand your consumer spending so they
can better tailor your rewards. But while loan loss
provisions have increased following a period of high
inflation, experts believe that Amex is more than
ready to weather a possible recession. They're not by any means
immune to a downturn. But at the same time, with
that high-spender affluent customer, those credit
losses are likely significantly lower than
some of the peers that are more focused on average
consumer, even subprime borrowers. And so there's
no reason to think that American Express won't have
a strong customer base after the next recession.
