American Express Co.’s (AXP, Financial) shares plunged to a four-month low after the company announced an expected loss in sales and profit in the current fiscal year as well as 2016 following the end of its exclusive deal with Costco Wholesale Corp (COST, Financial). AmEx, which has been the sole credit card to be accepted in Costco’s stores, failed to strike a deal that would have ensured the continuing partnership between both companies beyond March 31, 2016, when the current merchant acceptance and co-brand agreement ends. Consequently, the company’s stock was down 7% on Thursday, the lowest level since August 2011. The steep slide erased around $5.9 billion from the credit-card giant’s market value, which is still almost $88 billion. Although Costco shares also dipped 0.2% following the announcement, the company’s stock has performed far better on a year-over-year basis, logging in a 26.9 percent gain compared to AmEx’s 8.8% decline.
Intense Competition in Co-branded Cards Segment
Co-branding contracts usually include rewards programs and some publicity for both companies, with their branding appearing on the credit cards. While American Express renewed its multi-year co-branded agreements with Cathay Pacific Airways Ltd, Starwood Hotels & Resorts Worldwide Inc (HOT, Financial) and Delta Airlines Inc. (DAL, Financial) in 2014, the company was not able to pull through with the Costco deal.
The co-brand agreement between AmEx and Costco made up around 20% of Amex’s global loans and around 10% of in-force cards across the world in 2014, accounting for nearly $1 trillion in billed business in that year. Moreover, AmEx had exclusive access to the $113 billion revenue generated by Costco in full-year 2014. However, with Costco ceasing to accept AmEx credit cards at its stores across the US beginning in 2016, almost 8% of the card company’s global billed business is expected to be adversely affected. American Express announced that renewal rates for co-branded cards have shot up with competition in the segment intensifying in the past few years. Consequently, the company was unable to strike a deal with Costco that would have been economically beneficial to Amex as well as its shareholders.
New York-based American Express, known for catering to customers with a higher net worth, is a smaller competitor to MasterCard (MA, Financial) and Visa (V, Financial). AmEx cards were replaced by those of MasterCard Inc. and Capital One Financial Corp (COF, Financial) when the company parted ways with Costco in Canada last year. In all probability, AmEx would be looking at the same rivals taking over its business with Costco in the US too.
The Way Ahead
American Express, like many other businesses with revenue sources spread across the globe, is witnessing harsh foreign currency headwinds against a strong dollar. The company announced during its earnings release last month that it would be laying off around 4,000 employees as part of its restructuring process. Following the parting of ways of the two companies after a 16-year tie-up, AmEx expects its growth in earnings per share in 2015 to drop slightly from 2014 levels, owing to projected aggressive investments in the run-up to the contract termination. The company also expects its revenue and earnings growth in 2015 and 2016 to be negatively impacted by the new development.
However, AmEx is confident of achieving an EPS growth target of 12-15% over the moderate to long term. The company’s major focus for the future would be to replace profits associated with the partnership while working on opportunities in other business segments that offer both growth potential and attractive moderate to long-term returns.
Final Thoughts
Although American Express saw a good fourth quarter in 2014, with profits rising 11 percent to $1.45 billion, or $1.39 per share, versus an estimated $1.38 per share, the end of American Express’s contract with Costco in Canada in 2014 and in the US in 2016 is likely to put significant pressure on the company’s earnings bottom-line. Following the loss of Costco, experts estimate a reduced spending to the tune of $80 billion a year on American Express cards, including the use of the co-branded cards at businesses other than the 468 Costco outlets in the US and Puerto Rico. The AmEx stock currently carries a ‘hold’ rating from most of the market experts and analysts.
