Don't Leave Your Portfolio Without American Express - TheStreet

Don't Leave Your Portfolio Without American Express

The card issuer is hugely undervalued, and it has an edge over its competitors.
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Editor's Note: Jon D. Markman writes a weekly column for

CNBC

on

MSN Money

that is republished here on

TheStreet.com.

Investors looking for the best "green" investment in the stock market right now need look no farther than their wallets. Or the wallets of their bosses. Because it's none other than the king of credit cards, the emerald-hued financial-services provider

American Express

(AXP) - Get Report

.

One of the most universally appealing corporate brands in the world -- the very symbol of U.S. financial ambition and might from Manhattan to Mumbai -- American Express has also somehow become one of the cheapest and most disrespected stocks in the entire

Dow Jones Industrial Average

. The disconnect between its real value and the market's opinion at the moment is loony and unlikely to last, so file this one under "opportunity of a lifetime," and get ready to cash in.

Here's the deal: There is a school of thought in some morose corners of Wall Street that the residential real-estate slowdown, the subprime mortgage meltdown and the U.S. dollar fall-down will combine over the next few months in a swirling vortex of pain for the American consumer. This view holds that Americans will abruptly stop spending on travel, electronics and clothes because they have to set more aside each month for house payments, gasoline, bankruptcy attorney fees and antidepressants.

The facts don't bear out the bears' point of view, as you'll see in a moment. But that's OK, because this view has created an ideal chance to steal the stock. With American Express currently trading at $65 after a quick bump higher this week amid a rare spurt of optimism, I believe shares can shoot to $80 over the next 15 months if a couple of things go right -- a 23% move.

Undervalued Franchise

Part of the problem is that the market doesn't seem to know how it should set a value of credit card networks these days. Consider this paradox: Investors have given youthful rival

MasterCard

(MA) - Get Report

valuations ranging from 15 times earnings to 30 times earnings since it went public last year.

And just a few weeks ago, the market decided to bestow a valuation of 24 times forward earnings on the long-bumbling provider of the Discover card,

Discover Financial Services

(DFS) - Get Report

when it split off from

Morgan Stanley

(MS) - Get Report

. Yet American Express -- which has put up years of awesome cash flow and industry-leading return on capital, and which has undimmed prospects both at home and overseas -- is going for what amounts to just 16 times projected 2008 earnings. This is like pricing a Mercedes-Benz as if it were a Yugo.

American Express is going to report second-quarter earnings next week, and the results should open some eyes. You can expect total billed business, which is the typical marker of credit card companies' success, to be up as much as 15% on an annualized basis, to around $161 billion.

One of the reasons for this may surprise you. It turns out that a lot of people, especially those who have company-issued cards, use American Express cards to buy gasoline. And since gas prices are up 6% over last year, the value of what the industry calls "everyday spend" will be up at least that amount, which is higher than what most investors are expecting. American Express has been increasing its exposure to everyday spending steadily over the past half-decade to the point at which it is two-thirds of its entire billed business.

Moreover, the company has likely added as many as 1.5 million new accounts in the U.S. as well as another million accounts overseas in the quarter due to some smart marketing and an increase in the variety of cards sold, including a clever new type of metropolitan affinity card that provides spending awards to customers living in big cities like Los Angeles. As a result, it has almost certainly boosted market share in the last year and could very well shock the Street by doubling its current 5.2% share of the U.S. card business by 2011.

Charge-Offs Under Control

Meanwhile, charge-off rates for credit quality problems are under control, no matter how much bears believe they should be exploding. Credit reporting agencies say charge-offs for deadbeat accounts were up just a hundredth of a percent in the second quarter over the first quarter but are far below the three-year average of 4.6%.

The high average is probably partly due to the fact that new bankruptcy rules, which went into effect in 2005, created a boost in charge-offs at that time. But even if poor credit problems advance by as much as 30% annually through the rest of the decade, analysts believe that American Express and its peers over at MasterCard and Discover have prepared adequately through derivatives and insurance just as biscuit companies routinely hedge out some of their exposure to higher corn and wheat prices.

International business is another source of optimism at American Express, which has previously reported a 20% increase in international spending volume due to the rise of global trade. It is getting more out of its card members who travel overseas and charge large airline and hotel bills as well as from new accounts in fast-growing emerging markets where rising middle classes are just learning the joys of plastic.

MasterCard and American Express have both made major investments in allies overseas, with MasterCard in particular earning a windfall this month of more than $400 million on the extremely successful initial public offering of the Brazilian card company Redecard. Of course the decline of the U.S. dollar helps, too. Lehman Bros. figures that a dollar that was 3.7% weaker in the second quarter vs. the same period last year will boost international spending revenue by a roughly equivalent amount.

Everyday Growth

There's much more going on here besides straightforward business growth, as American Express, MasterCard and Visa -- which is expected to go public later this year -- are benefiting from consumers' accelerating worldwide preference for the convenience of using cards in the sort of everyday purchases for which they formerly paid cash.

U.S. consumer spending is expected to advance 5% annually through the end of the decade, to $8.8 trillion per year. The share of that spending that will be placed on cards could go as high as 56%, compared with 40% in 2005, according to industry researchers. That implies 13% annual growth in card spending volume, according to analysts, which gives the credit and debit card business an underlying growth path that is virtually unparalleled among mature industries. Figure that American Express alone should be able to achieve 12.5% revenue growth over the next five years, even if it never gains more market share.

I like American Express more than I do MasterCard and Visa in this scenario because it is both the card issuer and what the industry calls the "merchant acquirer," which means that the entire fee that comes through the transaction goes to American Express. In contrast, MasterCard and Visa share fees with banks, which are pressuring them to lower prices. American Express also has a greater proven ability to leverage spending by cross-selling other products and its merchants' services.

The bottom line: I'm expecting American Express to earn as much as $4.50 per share in 2009, which means that at today's level it's trading at a multiple of 14 times earnings. By the fourth quarter of next year, it should trade at least around 18 times earnings, so put a target of $80 on the stock and charge away.

At the time of publication, Markman had no positions in stocks mentioned in this column, although positions may change at any time.

Jon D. Markman is editor of the independent investment newsletter The Daily Advantage. While Markman cannot provide personalized investment advice or recommendations, he appreciates your feedback;

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