American Express Earnings Loom on Street

Updated from 7/20/01

Don't worry. You'll probably be safe leaving home today without this stock in your portfolio.

American Express (AXP Quote - Cramer on AXP - Stock Picks) reports its second-quarter earnings Monday afternoon, and it's not going to be a pretty picture. The credit card giant warned Wednesday that it would take an $826 million charge against earnings to cover the cost of junk-bond losses. On top of that, investors likely will be presented with slower-than-predicted revenue growth and murky earnings guidance.

Monday will mark the third time in as many quarters that the company will take a charge for junk bonds -- known in polite society as high-yield investments -- in its American Express Financial Advisors, or AEFA, unit. Never mind the company's assurances in April that there would not be another significant writedown in the AEFA portfolio.

Flagging Investors lose faith in AXP

The hefty $826 million charge is the largest yet at American Express, leading a number of observers to question the firm's understanding of the complicated, structured products it invested in. Indeed, CEO Kenneth Chenault's admission that the firm "did not fully comprehend" the risk of its high-yield investments in a conference call Wednesday morning suggest those questions are well-founded. "Given the extended downturn in the high-yield market, we have to wonder why AXP didn't figure out sooner it faced higher losses," said Gimme Credit analyst Kathy Shanley, who pens a daily newsletter on debt.

Asked about the timing of American Express' latest warning, which it issued just three business days before its second-quarter earnings report, a company spokeswoman said the firm needed the time to do a "comprehensive analysis" on the high-yield portfolio at the end of June.

Prudential banks analyst Bradley Ball characterized the high-yield writedown as the "third shoe" to drop for the company, the first two being its downward revision of earnings-per-share growth in January and the 18% drop in the company's first-quarter income in April. To Ball, the mere fact of a writedown this quarter wasn't surprising, but the size of it was. (Ball's firm has not done any recent underwriting for American Express.)

30,000 Feet

On its own, the junk-bond issue is worth worrying about. But it's not all there is to fret over. A number of experts are questioning the underlying fundamentals of American Express' business, including how the company will manage to maintain its much trumpeted long-term growth rate of 12% to 15% as a slowdown in corporate spending cuts into its Travel Related Services unit, a key earnings driver that contributes roughly 70% of the firm's net income.

"We question whether the past few years' worth of growth weren't overstated by AEFA's results," Deutsche Banc Alex. Brown analyst Mark Alpert wrote in a research note Wednesday, referring to the unit that includes high-yield investments. (Deutsche Banc has not performed any recent underwriting for the firm.)

American Express said Wednesday that billed business in TRS rose about 4% in the second quarter, compared with the prior quarter's 8% increase, a notable slowdown. Management has suspended guidance for 2001 at this point. But it has nonetheless adhered to its prediction of 12%-to-15% long-term growth, leaving many onlookers scratching their heads about where the expected growth will come from.

Cost-cutting surely could help American Express prop up the bottom line some. But hardly anyone was happy to hear Wednesday that on top of the current quarter's woes, the company expects to take another $310 million to $370 million in charges in the third quarter. Those charges will cover the cost of firing between 4,000 and 5,000 staffers beyond the already announced 1,600.

Transition Days

Not surprisingly, the backpedaling and inability to offer guidance on profit growth for the remainder of the year have led a number of analysts to take a dim view of the company. "We believe this story is one of massive transition and of questioned credibility," wrote First Union Securities analyst Meredith Whitney on Wednesday in a research note. (First Union has not performed any recent underwriting for American Express.)

With American Express' stock having sunk about 30% in 2001, some experts believe the seemingly endless discussion of the company as a takeover target will limit downside risk. It's been enough to boost the stock on a myriad of occasions. But the buyout speculation doesn't trump the fundamental concerns. "In our opinion, revenue growth prospects do not support the valuation," said Deutsche Banc's Alpert.

It's safe to say that the problems facing the company won't go away in one quarter. With the economy still showing signs of slowing, corporate spending could very well dip even more, further dampening the firm's revenue and earnings growth. Meanwhile, American Express has in recent years become more exposed to consumer credit, yet another lending area recently showing an uptick in charge-offs and asset deterioration.

At this point hardly anyone, including the company itself, assumes a rebound is imminent. "This quarter's big bath may not be the end of disappointments at AXP," said Gimme Credit's Shanley.

American Express wasn't making any big moves ahead of its earnings report in Monday trading. It was lately up 14 cents to $38.12.