Yesterday, American Express Company (AXP) reported fourth quarter operating earnings of 94 cents per share, well ahead of the Zacks Consensus Estimate of 90 cents and year-ago quarter of 59 cents. This excludes restructuring and other reengineering charges (related to the recent elimination of 500 jobs in the customer service operations) of $74 million (after-tax) or 6 cents per share.

Including the one-time charge, GAAP net income was $1.1 billion or 88 cents, up from $716 million or 60 cents in the year-ago period. However, the results from discontinued operations were nil during the reported quarter against one cent in the year-ago quarter.

The significant surge in earnings for American Express was attributable to an increased usage of cards with lesser defaults as consumers resumed their spending at a level similar to the pre-recession period. However, strong growth in the top-line, lower tax rate and substantial reduction in provision for losses was partially offset by higher-than-expected operating expenses and lower interest income.

American Express’ card members’ spending increased 15% to $197.7 billion over the prior-year quarter. The increase came from international cards that rose about 8% year over year to $42.1 million while cards in use remained steady in the US.

Behind the Headlines

American Express posted total revenues, net of interest expenses, of $7.32 billion, up 13% year over year from $6.49 billion and almost flat from the Zacks Consensus Estimate.  The revenue augmentation reflects the consolidation of securitized card member loans and related debt on the balance sheet in the first quarter of 2010.

Additionally, the increase in revenues was supported by higher spending and higher travel commissions by card members, offset by a smaller loan portfolio due to lower interest income and lower yields on both the securitized and non-securitized portions of the portfolio. Over the last several quarters, American Express has generated lower interest income on account of lesser borrowing by card members and clearing of their outstanding debt.

Provisions for losses were $239 billion, down 68% from $748 million in the prior-year quarter, although lending balances and yield continue to remain sluggish. The year-over-year decrease in provisions for losses was driven primarily by continued improvement in credit quality on the charge and credit card portfolios.

Total expenses of American Express mounted to $5.6 billion in the fourth quarter of 2010, up 17% year over year from $4.8 billion, reflecting growth of investment in business building initiatives along with higher reward costs.

Segment Results

U.S. Card Services reported a net income of $701 million, up 70% from $413 million incurred in the prior-year quarter. Total revenues net of interest expenses increased 18% year over year to $3.8 billion from $3.2 billion.

International Card Services net income came in at $102.0 million, up 48% from $69.0 million in the year-ago quarter. Total revenues net of interest expenses were $1.2 billion, up 2% from the year-ago quarter.

Global Commercial Services net income increased 6% to $106.0 million from $100.0 million in the prior-year quarter. Total revenues net of interest expense increased 7% year over year to $1.2 billion, reflecting increased spending by corporate card members and higher travel commissions and fees.

Global Network & Merchant Services reported a net income of $268.0 million, up 34% from $200.0 million in the prior-year quarter. Total revenues net of interest expense increased 15% year over year to $1.2 billion from $1.0 billion. The company’s billed business continued to witness improvement in the U.S. and beyond.

Corporate & Other reported net expenses of $115.0 million compared with a net loss of $72.0 million a year ago. The results for both periods reflect income of $220 million ($136 million after-tax) form the previously announced MasterCard Inc. (MA) and Visa Inc. (V) settlements.

Highlights of 2010

For full year 2010, American Express’ net income was $4.06 billion or $3.35 per share as compared with $2.13 billion or $1.54 per share in 2009. However, earnings were a nickel below from the Zacks Consensus Estimate of $3.40 per share. Total revenues net of interest expenses increased 13% year over year to $27.82 billion from $24.52 billion in 2009. This was almost in line from the Zacks Consensus Estimate of $27.78 billion for 2010.

As of December 31, 2010, American Express’ return on average equity (ROE) was 27.5%, up from 14.6% as of December 31, 2009. Return on average common equity (ROCE) was 27.2%, up from 13.6% in the year-ago period.

Competitors in Good Steed

Rival card company Capital One Financial Corporation (COF) also reported its fourth quarter results last week on January 20, 2010, wherein income from continuing operations were $1.53 per share, substantially ahead of the Zacks Consensus Estimate of $1.35. This also compares favourably with earnings of 89 cents in the year-ago period.

Another peer, Discover Financial Services (DFS), also reported a third quarter profit from continuing operations of 64 cents per share on December 16, well ahead of the Zacks Consensus Estimate of 42 cents and loss per share of 14 cents recorded in the year-ago quarter.

Other competitors of American Express, such as Visa and MasterCard are yet to report their quarterly results. While Visa will report its fiscal first quarter earnings after the market closes on February 2, MasterCard will report its fourth quarter earnings before market opens on February 3, 2010.

Our Take

American Express has pulled itself out of the recession more quickly than its rivals, owing to its creditworthy customers. Moreover, less reliance on revolving credit and back-end fees has helped gain competitive advantage while also improved its overall risk profile. Besides, there has been an impressive recovery in credit trends, with increased card spending and strong billings over the last few quarters.

However, we remain concerned about the challenging regulatory economy and the impact of new regulations on the card industry. We fear that the new regulations under the Consumer Protection Act, Dodd-Frank Act and Durbin Amendment, all regulated in 2010, are expected to make American Express’ credit cards costlier and will in turn result in lower interest income and loan fee income.

The volatile economic outlook raises near-term caution. Hence, we remain Neutral on the stock with a Zacks #3 Rank.

 
AMER EXPRESS CO (AXP): Free Stock Analysis Report
 
CAPITAL ONE FIN (COF): Free Stock Analysis Report
 
DISCOVER FIN SV (DFS): Free Stock Analysis Report
 
MASTERCARD INC (MA): Free Stock Analysis Report
 
VISA INC-A (V): Free Stock Analysis Report
 
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