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Morningstar | Rewards Expense Continues to Weigh on Amex's Earnings

Wide-moat American Express finished 2018 at a modestly slower pace than we had expected, generating revenue of less than $10.5 billion. Throughout the year, it generated year-over-year growth in billed business ranging from the upper single to low double digits. In the fourth quarter, Amex saw some deceleration in year-over-year growth in billed business, to 6%. Some of this is attributable to Amex facing tougher comparisons. Nevertheless, growth in average card member spending has slowed. For the quarter, average card spending increased only 2.2% from the previous year, a 300-basis-point decrease from growth achieved during the same period in 2017. This is largely the reason for the modest underperformance. For the quarter, the company earned $2.32 per share, benefiting significantly from a favorable tax gain. Had Amex paid a more normal 22% tax rate, it would have earned about $1.85 per share, a $0.03 decrease from the previous quarter. For now, we're maintaining our fair value estimate of $110 per share. We will update our model to include full-year results but do not expect any material changes to our fair value estimate.

This quarter’s performance and guidance demonstrate the toll that rewards and marketing expense are taking on American Express. Though fourth-quarter revenue increased 8% during the quarter, pretax income climbed only 2%. In addition, Amex guided for revenue to increase 8%-10% in 2019 while earnings per share will increase 13%. This suggests to us that the company will buy back a lot of shares, because we think it will be hard for American Express to expand margins while still making the investments it needs to improve its technology while matching the rewards offerings of rivals.

Though JPMorgan’s Chase Sapphire Preferred no longer offers the 100,000-point signup bonus for new cardholders that it did when the card was launched, Amex’s rival did increase its signup bonus to 60,000 points from 50,000 in the fourth quarter. In addition, Capital One’s Spark card for businesses offering 200,000 miles appears to be a direct attack on American Express’ valuable commercial franchise. To us, Capital One’s Spark represents an additional front in the war for credit card wallet share. American Express maintains that its valuable network of Centurion Lounges will allow it to weather this threat. We don’t doubt business travelers love these lounges. However, we suspect Capital One’s card will have some success and force American Express to continue spending. Should Amex’s rivals increase rewards in 2019, Amex’s earnings forecast of $7.85-$8.35 per share may be hard to achieve.