Takeaway: We added AXP to Investing Ideas on the short side on 9/27.

Stock Report: American Express (AXP) - HE AXP table 10 06 16

THE HEDGEYE EDGE

Many investors don’t understand the bigger picture drivers for American Express. They don't grasp the longer-term trends affecting their business and the various challenges the company faces across its different business lines. While once a great, blue-chip growth company, American Express is entering a new phase of its corporate life: stagnation.

While the company still generates high returns on capital, and returns significant capital to shareholders, the primary and secondary businesses are set to become headwinds rather than tailwinds within the next few years. This will make it difficult, if not impossible, for the company to sustain its current earnings multiple and will make earnings growth harder and harder to achieve.

INTERMEDIATE TERM (TREND)

American Express is facing significant longer-term challenges, which we enumerate below. In the intermediate term, the company is grappling with the loss of Costco – its largest single partner, fluctuations in the dollar, and growing challenges on the competitive rewards landscape. We expect the company will downplay both the Costco and dollar headwinds by steering investors towards “ex” metrics to argue that things are fine and the business is growing well. But in reality, the business is struggling.

The latest development to keep an eye on is the first sign of credit quality deterioration setting in. American Express provides monthly updates around the 15th of every month indicating the credit quality performance of its loan book. It will be interesting to see whether the emergent signs of weakness that appeared last month continue.

LONG TERM (TAIL)

The core business at American Express is facing growing pressure from the longer-term dual headwinds of falling pricing power and slowing volume growth. Volume growth is slowing both domestically and abroad. This has been the case for several years now and the 2-3 year outlook should see this trend continue.

Meanwhile, pricing power has been in steady decline for the better part of the last two decades, but has been accelerating in the last few years. Again, we see no reason for this trend to change. The co-brand/partnership business at American Express has taken some big hits recently, most notably the loss of Costco. We wouldn’t be surprised to see more challenges in this segment of American Express’ business.

Separately, the company still derives over 20% of revenue and earnings from its lending business. We believe the credit cycle is in its twilight and will begin to deteriorate in the coming 12-24 months. This will put pressure on American Express’ Earnings in the form of higher provisioning expense.

ONE-YEAR TRAILING CHART

Stock Report: American Express (AXP) - HE AXP chart 10 06 16