Firm notes their view on American Express is largely unchanged from initiation on May 11, 2009, and reiterates their Underperform rating. They remain primarily concerned that returns will not bounce back to near the historical levels investors appear to expect, and given that a good deal of optimism is embedded in the valuation of shares at present, they think AXP is poised for a pullback. Firm anticipates earnings pressure will persist due to:
1) likelihood of persistently above-average levels of credit pressure for the next several years;
2) negative impact from the challenging economic/regulatory environment on billed business and card fee revenue (combined representing roughly 63% of total revenue at 2Q09) as the company pulls back its lending activities;
3) higher capital levels (lower financial leverage) resulting from defensive credit moves, as well as from potential for more conservative regulatory capital guidelines. A bill crafted by Senator Dick Durbin (D-IL) targeting card interchange fees could also negatively impact American Express, though RBC hesitates to put significant weight on this factor given uncertainty of timing or ultimate passage in Congress.
Recent signs of credit improvement reported by the company are positive, though they remain tenuous, and they believe meaningful further improvement will only come as a result of declines in unemployment. Historically, charge-offs continue to rise well beyond the end of a recession, so the firm is not convinced that charge-offs are on the mend, and they think they could erode further later this year. Even if credit trends were to continue to improve, we doubt that charge-offs would decline meaningfully below 7% in even the best case by the end of 2010, meaning earnings performance will still remain under pressure for a significant period of time
Even a Middle of the Road View Suggests Shares Are Over-Valued at Present: So what happens if RBC's anemic recovery view is too gloomy? If they weigh the outcomes based on a less pessimistic probability-based approach, assuming there is a 10% chance of a V-shaped recovery, a balanced 40%/40% chance of moderate or anemic recovery, and a 10% chance of a challenged recovery, shares still appear expensive at current levels, in our view. The chart below illustrates the set of outcomes from this weighting and share prices based on various 2012 forward P/E and P/B multiples, assuming a 12% discount rate.
Exhibit : Discounted Present Value of AXP Shares – Probability-Weighted Approach
Caveat Emptor - Reiterating Underperform: Investors should be wary of owning shares at current levels, in firm's view. They continue to believe that at recovery AXP will more likely see lower than historical ROE, and that earnings growth will also be more modest than in the past. $20 price target is more reasonable for shares on this basis.
Notablecalls: Here are some thoughts on this call:
- The market surely favors the call today. The stock seems to have gotten ahead of itself in recent weeks and is due for a sharp correction. RBC provides the que.
- Note that Citigroup upraded AXP to Buy and added it to their Top Picks Live list with a $36 tgt. That's not much upside. RBC's $20 tgt kinda implys the risk/reward ain't spectacular here.
- I'm troubled by RBC's 10% probability of a V-shaped recovery. Could the market be THAT wrong? Because right now it seems everyone is expecting a V-shaped bounce off the lows.
- Why did BAC rally so big on Friday? The word is it was in anticipation of positive master trust data due out this week. That's something to think about because it surely will have an impact on AXP as well.
How much will AXP fall today?
It's going sub-$31 for sure...next stop 30.50 and then maybe even lower. We could see sub-$30 levels as soon as today if the market doesn't put together a bounce.