How would American Express behave in a recession?

The payment and credit card company American Express (AXP -2.58%) just posted monster results for the second quarter of the year, boosting revenue by more than 30% year-over-year and adding a record 3.2 million new cards in the quarter. While the stock still tends to trade at a higher valuation, investors may be increasingly concerned about the company as it heavily serves the consumer, which could soon find itself in a recession. Let’s take a look at how American Express might fare during a recession.

Understanding the business of American Express

American Express has one of the most enviable credit card brands in the world, which allows it to charge subscription fees on many of its credit card products. The bank is also making money on credit card loans, which totaled nearly $100 billion at the end of the second quarter. Being in the credit card business obviously exposes the business to the consumer, who can struggle during a recession and lead to higher loan losses.

Image source: Getty Images.

But while American Express has a large portfolio of loans, revenue from those loans only accounted for about 18% of the company’s total revenue in the second quarter of the year. American Express earned 59% of its revenue from rebates, which comes from the commissions it collects from facilitating transactions between merchants and card members on its payment network. Almost any business that accepts credit cards can accept American Express, and the company’s payment network saw nearly $395 billion in volume in the second quarter.

While consumer credit companies can fight inflation, payment networks can fare better because when items cost more, American Express collects a higher percentage-based fee and generates more revenue. of discount. While higher interest rates can increase loan defaults, American Express serves a higher quality customer base than many competitors, many of whom are super-prime customers. However, in the event of a severe recession, the company would likely see higher default rates and less spending on its network.

But another benefit of American Express is the fact that spending on travel and entertainment, an area in which the company excels, rose significantly in the second quarter even as economic growth weakened. It’s unclear how long that could last, but American Express CEO Stephen Squeri, in the company’s recent earnings call, said he doesn’t expect demand for travel and entertainment to decline. anytime soon.

American Express has undergone stress tests

American Express also proved to be one of the top performers in the Federal Reserve’s annual stress test exercise this year, in which the Fed subjects the nation’s largest banks to a severe hypothetical economic situation to ensure that the banking system is on sound footing.

In a severe nine-quarter delay, in which unemployment tops 10%, commercial real estate prices fall 40% and stock prices fall 55%, American Express would maintain healthy capital levels, take around $14 billion of loan losses and would generate a pre-tax profit of more than $5 billion. Of the 33 banks subjected to this year’s stress test, only one other reported higher earnings than American Express. Chief Financial Officer Jeff Campbell also noted that, in the stress tests, American Express had the highest profit margin as a percentage of assets of the 33 participants.

Management said on its recent earnings call that the company was bracing for worsening economic conditions, although it did not see deterioration in customer credit in the first half of the year. Even though American Express management raised its full-year revenue forecast, it maintained its full-year profit forecast, acknowledging that it may need to build more reserves for loan losses. later this year.

Is American Express a good stock to own in a recession?

Credit card companies are not ideal investments with a recession potentially on the horizon. But American Express is much more than an ordinary credit card company when you consider its high-quality customer base, the strong brand that allows it to charge subscription fees on its products, and the payment network, which can actually hedge inflation up to a point. Degree. American Express would likely be hit by a severe recession, but given its stress test results and growth potential, it’s a good stock to hold for the long term, even if there is a recession. at one point.

American Express is an advertising partner of The Ascent, a Motley Fool Company. Bram Berkowitz has no position in the stocks mentioned. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.

Comments are closed.