Don't Count on a Quick Rebound From American Express

There's no doubt that American Express(AXP) is one of the premier brands in the financial services industry. In fact, for years, AXP has earned risk-adjusted returns that surpass the rest of the industry.

The question is, how long can it sustain that? The year 2001 couldn't have been a worse one for American Express. And with consumer spending just beginning to slow and corporate profits under pressure, I can't imagine that its core travel-related charge card business is going to fare much better in 2002.

I know many portfolio managers who don't want to miss this stock -- if they haven't already. Since hitting a 52-week low recently of $24.20, AXP has bounced right back to $30, so it's not that cheap anymore. AXP is trading at a P/E ratio of 15 on 2002 estimates of $2.02 per share. That compares with a 10-year median P/E of 17.4 and a low of 9. On a price-to-book value ratio, AXP is even less tempting, trading at 3.3 times book value compared with a 10-year median of 3.2.

Yes, a takeover is quite possible, particularly in light of the recent resolution of the lawsuit AXP filed against rivals Visa and MasterCard. Assuming it's not reversed on appeal, the favorable ruling for AXP means banks can now issue Amex cards as well as Visa and MasterCard cards. As a result, many are speculating that AXP is now an attractive takeover candidate for a major bank.

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However, saying that 2001 was a bad year for AXP is a bit like saying Bill Gates has a lot of money. First, there were the well-publicized problems at American Express Financial Advisors, where AXP had to take a big write-off in its high-yield bond portfolio -- a major embarrassment.

Then worries emerged about the slowing economy's impact on the travel-related business, which, being transaction-oriented, is highly correlated with economic activity, perhaps even more so than for other companies in the group. The tragic events of Sept. 11 only heightened these earnings concerns, and deprived American Express of its headquarters for well into the foreseeable future, as well.

Many of these issues carry over into next year and, if anything, worsen. American Express Financial Advisors has hopefully cleaned up its act with the benefit of more oversight. But there's no visibility at all on a turn in corporate spending, so travel and expense spending will continue to be weak next year. Then you have to worry about the interchange fee that Amex charges merchants who accept its card. It's still a hefty premium to competitors Visa and MasterCard, but it's been shrinking as Amex changes its mix of customers, cutting better deals with new merchants. This decline will likely eat into Amex's industry-leading return on managed assets, and that could have an impact on the company's brand equity.

Finally, there's the credit card business, which is arguably in much better shape than it was in the last recession in 1990. But that's an unfair comparison, because back then, the main credit card strategy -- Optima -- was an unqualified disaster. Since then, Amex has successfully restructured its credit card business. Nevertheless, it hasn't experienced a serious down cycle yet, so it's hard to say how well that business will cope with the likelihood of rising delinquencies. Take a look at the stocks of credit card lenders like Providian (PVN), whose shares are down 78% from their high, to get an idea of what can happen here.

Don't get me wrong -- I love the Amex brand, and so do many others. As one friend of mine said, "This is a portfolio manager's stock." I just don't love the price above $30, particularly with little earnings visibility. This company reports third-quarter earnings Oct. 22, and believe me, it will be ugly. But if the stock heads back down toward its old low of $24, I'd definitely be interested again.

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