Media Moves

Coverage: Amex and Costco split

February 13, 2015

Posted by Liz Hester

American Express and Costco are breaking up. The pairing seems unlikely, but what was even more surprising was the hit to American Express’s stock after the announcement.

Robin Sidel had this story in The Wall Street Journal:

American Express Co. and Costco Wholesale Corp. are ending their 16-year relationship, a surprise move that pummeled AmEx’s stock price and will trigger a major upheaval in the card industry.

The unusual partnership, in which Costco exclusively accepted AmEx cards, had driven a significant chunk of business to the New York card company. In addition, AmEx and Costco issued a credit card together that could also be used at other merchants. When the arrangement ends next year, millions of customers will be forced to use a different credit card when shopping at the wholesale store.

The failure to agree on new terms was a fresh blow to AmEx, which was already falling short of some sales targets. American Express Chief Executive Ken Chenault said the move, affecting roughly one in 10 AmEx cards in circulation, would eat into the company’s results in the next two years.

On Thursday, AmEx’s shares dropped $5.53, or 6.4%, to $80.48, its largest one-day percentage decline since August 2011.

The move sets up a race among credit-card firms to team up with the fast-expanding wholesale club, which sells everything from car tires to smoked salmon.

The Bloomberg story by Noah Buhayar and Sonali Basak said the retailer was putting cost savings first:

Bob Nelson, a spokesman for Costco, said in a phone interview that the retailer is “all about saving money” to give customers more value. A few years ago, the company switched from serving Coca-Cola Co. products at its store food courts after getting a lower bid from PepsiCo Inc. Berkshire is the largest shareholder in Coca-Cola.

“At the end of the day, it’s all about saving money for our members and widening the gap between us and our competitors,” Nelson said. “If that means Pepsi over Coke, that’s what we’re going to do. If it means a different credit-card provider that’s going to be a better offering for our members, we’re going to try to do that.”

The Reuters story by Avik Das said the competition in the co-branded business was intensifying and that several other issuers were waiting to take over from Amex:

Competition in the co-branded card business has intensified in recent years, leading to higher renewal costs, Chenault said on a conference call.

Costco declined to comment on the move, which follows its decision to drop AmEx in Canada last year.

Capital One Financial Corp and MasterCard Inc replaced AmEx as Costco’s card partner in Canada, raising speculation that the companies could also replace AmEx in the United States.

Capital One, whose shares were up 2.6 percent in early afternoon trading, did not respond to a request for comment. MasterCard’s shares were up 2.7 percent.

American Express renewed co-branded contracts with Delta Airlines Inc, Starwood Hotels & Resorts Worldwide Inc and Cathay Pacific Airways Ltd in 2014.

Costco, which sells everything from jewelry to fresh produce at its cavernous members-only stores, reported revenue of $112.64 billion for its fiscal year ended Aug. 31, 2014.

Philip Van Doorn wrote for MarketWatch that dropping Amex made Discover look like a better investment:

During a conference call on Thursday, Chenault said: “More than 70% of the purchase volume from cards that we issue takes place on non-co-branded products.” That means nearly 30% of the company’s transaction volume comes from co-branded products, underscoring the severe blow from the loss of Costco. The CEO said American Express will be going after new co-branding deals, since “a number of major partnerships that are not currently with American Express will be coming up or renewal during the next few years.”

So there’s hope that, over the next few years, American Express will be able to limit the damage.

Still, American Express expects a “significant impact” from the loss of the partnership on sales and earnings for 2015 and 2016. “The Costco U.S. co-brand portfolio makes up about 20% of worldwide loans and about 10% of worldwide cards in force,” according to CFO Jeffrey Campbell.

Chenault expressed confidence that, after 2016, American Express could return to increasing its annual earnings per share by 12% to 15%.

Among the 30 largest U.S. banks by total assets, American Express has had the strongest annual returns on common equity over the past four years, ranging from 23.53% to 28.84% (in 2014), according to FactSet. For the four years, Amex’s average ROCE has been 26.92%. The stock closed at $86.01 Tuesday and traded for 13.1 times the consensus 2016 EPS estimate of $6.58. Of course, depending on the action for the stock, the forward P/E may climb, as analysts lower their earnings estimates over coming days.

Discover Financial Services provides an interesting contrast to American Express. It is a much smaller company and lacks the co-branding relationships enjoyed by Amex. Discover’s return on common equity has ranged from 24.20% (in 2014, according to Oppenheimer) to 29.96%, for an average of 26.38%, ranking a close second to Amex. And its stock trades for only 10.3 times the consensus 2016 EPS estimate.

Investors are certainly running for the exits right now. If American Express is unable to compete for every day consumers, that’s a large market the company is giving up. This could either be the beginning of a downslide or a slight misstep for the iconic card. Investor sentiment will be critical in the coming weeks.

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