Last October, when American Express Company (NYSE: AXP) reported its third-quarter earnings, longtime company CEO Kenneth Chenault announced he would be retiring in early 2018. Chenault, who has been with American Express since the 1980s, took over as chairman and CEO of the credit card giant in 2001 and led the company through tumultuous times, notably 9/11 and the financial crisis of the last decade.
When Chenault announced his retirement, Warren Buffett, Amex's largest shareholder, released a statement saying, "Ken's been the gold standard for corporate leadership and the benchmark that I measure others against." While Chenault's record was certainly not perfect -- it was under his watch that American Express lost its long-standing exclusive deal with Costco Wholesale -- it should be noted that the company's stock almost perfectly matched the S&P 500 index during his tenure, far from a disastrous performance.
Stepping in to fill Chenault's shoes is American Express Vice Chairman Steve Squeri, who himself has been with the company for three decades. In the company's third-quarter conference call, Chenault gave Squeri his blessing before stepping down, saying:
Just because American Express has recovered from its post-Costco swoon, though, and everyone is saying the right things, doesn't mean Squeri won't face some serious challenges immediately after filling the position. While every Fortune 500 company comes with its own trials, let's take a closer look at three of the biggest tests facing the credit card issuer at this moment.
1. Maintaining the company's world class credit worthiness
Compared to its lending peers, American Express has long maintained a substantially lower net write-off rate, loans that the company categorizes as unlikely to ever be collected. In the third quarter, American Express's net write-off rate was just 1.8%. For comparison's sake, Discover Financial Services (NYSE: DFS) charge-off rate was 2.63%, and Synchrony Financial's (NYSE: SYF) charge-off rate was 4.95%.
However, AmEx's lower write-off rate does not make it immune to the higher loan-loss provisions seen across the industry in recent quarters. Loan-loss provisions are funds set aside for loans not yet collected. In American Express's third quarter, that number spiked to $769 million, a 53% increase over 2016's third quarter.
While all credit issuers are experiencing similar increases, American Express must maintain its credit worthiness -- not only to maintain to its valuation but also for the obvious reason that loan losses obviously ding earnings. In the lending industry, American Express enjoys a premium valuation compared to its peers, largely due to the perception that its loans are more sound. For instance, American Express currently has a P/E ratio of more than 19, while the peers we mentioned earlier, Discover and Synchrony, have P/E ratios of 13 and 15, respectively. If loan losses continue to increase significantly, not only will Amex's earnings take a hit, but its valuation probably will too, having the effect of a double-whammy on the stock price.
Outgoing CEO Chenault said one of the primary reasons the credit card company could keep write-off rates so low over the years is that 50% of new loan growth is coming from existing customers, whom American Express obviously knows better than new customers. This familiarity allows AmEx to manage credit risk responsibly while still growing its loan portfolio. If Squeri wants to keep growing responsibly, he needs to continue to realize loan growth from existing customers.
2. Reaching the millennial generation
Many have questioned whether American Express has a problem reaching millennials with its core products, but in the third quarter, management announced 35% of new customers came from this key demographic. This success comes on the heels of the company tweaking its reward offerings to better appeal to a new generation of working professionals amid an intensely competitive environment.
One such change was to offer Uber benefits for Platinum card holders. Another was introducing the Pay It Plan It mobile platform, which allows card holders to select larger purchases from their monthly statement and assign them a unique, interest-free payment plan. Chenault believed this plan would be a hit with millennials because "they want simplicity and transparency and the ability to access this on their mobile phone."
Squeri needs to continue to find ways to reach this demographic by offering other platforms and rewards that appeal to them. It doesn't make his job easier that many millennials have not shown any interest in carrying credit cards.
3. Mobile and digital innovation in a changing payments landscape
In late 2017, American Express announced it would be forming a cross-border partnership with Banco Santander using the blockchain network of cryptocurrency Ripple (XRP-USD). The limited test is supposed to check whether such cross-border payments could be done both faster and cheaper than with existing payment channels. Innovation like this has seemingly been lacking in recent years.
As other payment networks have invested large amounts in fintech start-ups or acquired firms working on game-changing payment security technology, American Express has seemingly focused on increasing lounge access rewards and securing new co-brand deals. While these matters are obviously important, American Express needs to make sure it does not get left behind in a payment landscape that is quickly shifting toward digital and mobile platforms.
Hopefully, Squeri approaches past practices at AmEx with an open mind. For instance, one seemingly easy move that might help the company capture a segment of the younger generation is forming a partnership with PayPal Holdings; AmEx is seemingly the last financial company on the planet that has yet to strike a deal with the digital wallet platform, and yet, such a simple move might be enough to move the needle toward acquiring new millennial card holders.
None of this is to suggest Squeri is taking over a struggling company. Far from it! American Express shareholders had a year to remember in 2017, and the company continues to be one of the most respected credit card issuers in the United States. That being said, Squeri has plenty of work to do once he takes the job on Feb. 1. For shareholders' sake, I hope these three challenges are foremost on his mind.
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Matthew Cochrane owns shares of PayPal Holdings. The Motley Fool owns shares of and recommends PayPal Holdings. The Motley Fool recommends American Express, Costco Wholesale, and Synchrony Financial. The Motley Fool has a disclosure policy.