American Express' 3 Step Plan to Get Back on Track

By Matthew Cochrane Markets Fool.com

American Express Company (NYSE: AXP) reported earnings last week in what was largely a mixed bag. Revenue came in at $8.02 billion, an approximate 4% decline from last year's fourth quarter. On a GAAP-basis, earnings per share were $0.88, a decline of only 1% year over year (but note that adjusted EPS was down more than 25% to $0.91).Billing growth decreased about 3%.

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Image source: American Express Company

But it should be noted that once the numbers were adjusted for the loss of the Costco Wholesale Corporationco-brand card, they looked considerably better. With the Costco loss filtered out, revenue was up a decent 6% and billing growth increased a healthy 7%.

In the conference call following the earnings, American Express management outlined concrete steps they believe will lead the company to prosperous returns for investors well into the future. Here are three such steps currently under way:

1. Return significant capital to shareholders

American Express CFO Jeffrey Campbell heavily emphasized the amount of capital the company had returned to shareholders through dividends and buybacks the past fiscal year:

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We again used our strong balance sheet position to return significant capital to shareholders. We bought back $1 billion worth of shares in the quarter and again saw our share count drop by 7% versus the prior year. For the full year, we returned 99% of the capital we generated to shareholders in the form of dividends and buybacks.

American Express's accomplishment in buying back so many shares at a discounted rate should truly be celebrated by investors. Rarely do you see companies step up buybacks when the company falters and there is a chance to retire stock while it's undervalued.

Of course, with the stock well off its lows, the company will probably not be able to reduce its share count by the same amount this year. But management deserves kudos for paring a whopping 7% of outstanding shares.

It should also be noted that in October, American Express increased its dividend 10% to $0.32 per quarter. At the time, this raise brought up the yield to a bit over 2%, though it now stands around 1.7%.

2. Targeting new card members through proprietary channels

American Express had previously acquired a good percentage of its new card members through Costco. When the deal with the discount warehouse fell through, management had to scramble fast to find ways to replace that avenue of finding new accounts. It appears management has done this. Campbell stated:

During the quarter, we acquired 1.6 million cards across our U.S.-issuing businesses and $2.4 million on a worldwide basis, which remains above our historical average levels and demonstrates that we have now effectively replaced Costco as a distribution channel with our own proprietary activities.

Even better, Campbell later stated these customers have similar credit scores and financial backgrounds to existing card holders and have a "little higher propensity to carry revolving balance". In short, Campbell said the new customers make for "very, very good economics".

Other advantages of acquiring card members this way include more card fees collected. Net card fees grew to $725 million, a 6% increase year over year.

Of course, these new customers didn't magically find their way to an American Express credit card application. All this growth came at a record-setting cost. For the quarter, the company spent an eye-popping $1.2 billion on marketing and promotion expenses, the most in company history. That's almost a 30% increase sequentially and a 55% increase from the average amount spent during a quarter in 2015 on marketing and promotions. That's a lot!

Image source: American Express Company, Earnings Conference Call Q4'16 Slide Presentation

Still, if these customers are of the same industry-leading credit quality as American Express's existing card members and prove to be more profitable than customers previously acquired through co-brand channels, it might be money well-spent.

3. Increase in merchant coverage

Campbell said the company is working hard to repair its perceived image of not being accepted by many merchants when reality is far different.

We are making steady progress on accelerating merchant coverage, particularly in the U.S., and our fourth quarter Shop Small promotion was an early step in raising Card Member awareness.

Shop Small was a fourth quarter campaign designed to highlight smaller merchants in the geographic area of the card holder now accepting American Express as a method of payment.

OptBlue is another campaign they're running aimed at retailers who do not yet accept American Express. The program attracts new merchants by offering different price options, free online ads, and a listing on the Shop Small Map. It is easy to see how these benefits would appeal to small business owners.

By returning capital to shareholders, finding more-profitable new customers through its own channels, and expanding its merchant coverage, American Express hopes to signal to the market that it is not only over Costco, but better off for it as well. If management can do all this without spending record amounts on marketing every quarter and still return significant capital to shareholders, the company might even be able to pull it off.

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Matthew Cochrane has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Costco Wholesale. The Motley Fool recommends American Express. The Motley Fool has a disclosure policy.