DFS Discover Financial Services

Basking in the glory of the excellent stress test result, yesterday the board of American Express Co. (AXP) (AmEx) announced an 11% dividend hike and robust stock repurchases in an attempt to return excess wealth to investors.

The central bank of the US released its annual capital stress test earlier this month, which put 19 large banks under the scanner to test the resistance quality of the banking bellwethers amidst an economic shock. AmEx emerged with flying colours, notching a seat among the 15 banks that passed the test.

Accordingly, AmEx has raised its regular quarterly dividend to 20 cents per share from 18 cents, which is payable on May 10, 2012 to the shareholders of record as on April 5, 2012. This marks the first dividend hike by the company since November 2007. However, it continued to pay regular dividends through the peak recessionary period (2008-10) unlike most of its peers who chopped off or suspended dividedn payout over this period.

Seeking a ‘no objection certificate’ from the Federal Reserve (Fed) on its capital distribution plan AmEx’s board also announced its intention of buying back about 150 million shares from time to time through open market operations. The latest sanctioned stock repurchases substitutes the prior 200 million share buyback program, which had about 38 million outstanding.

Additionally, based on Monday’s closing price of $58.66, AmEx’s dividend yield currently stands at about 34%, while its stock buyback program currently stands at about $8.8 billion. AmEx’s market price has escalated over 24% so far in 2012 and reflects AmEx’s potential of significantly enhancing the shareholder value in the near future.

AmEx Fundamentals Firm

AmEx enjoys a strong capital position with a Tier 1 risk-based common ratio of 12.3%, at the end of 2011, well above the current regulatory requirement. Excess cash and securities of $18 billion at 2011-end, improved deposits and strong ROE had also paved way for resumption of share repurchases in the third quarter of 2011. Thenceforth, the company bought back shares worth $2.3 billion in 2011, thereby distributing about 56% of capital generated through share repurchases and dividend payments.

On a cumulative basis, since 1994, the company has distributed about 64% of capital generated through share repurchases and dividends. The latest acknowledgement from the Fed that AmEx’s capital flexibility should continue to remain intact even after capital deployment through share repurchases and dividend has further boosted the company’s drive to continue with the share repurchase activity in 2012 more aggressively.

Besides sustaining over 25% ROE growth, going ahead, management expects to consistently invest 50% of its excess capital in the business while paying out the remaining 50% to the investors through dividends and share buybacks. Hence, according to a regulatory statement filed by AmEx, the company anticipates to repurchase about $4 billion of common stock in 2012, while the remaining $1 billion of the buyback package is expected to be completed in 2013. Nevertheless, share repurchases will be dependent on the market conditions, the company’s business developments and operating performance in the upcoming quarters.

Going back to the stress test result details declared earlier this month, 15 of the 19 top banks satisfied the Fed with their capital requirements. While JP Morgan Chase &Co. (JPM) was the first to announce a dividend hike, other banking giants followed suit and included the likes of Morgan Stanley (MS), Wells Fargo & Co. (WFC), BB&T Corp. (BBT), Goldman Sachs Group Inc. (GS) and Discover Financial Services (DFS). Thus, the banking giants showcased an improved and healthy capital flexibility since the downturn in 2008 and looks to be en route to attain stability. However, four banks – MetLife Inc. (MET), SunTrust Banks Inc. (STI), Citigroup Inc. (C) and Ally Financial failed to meet all of the Fed criteria in the stress test.

Our Take

Fundamentally, AmEx has been driving its growth profile through improved credit quality. Alongside, the company has been upgrading its digital payment platform through strategic alliances, which will not only expand the company’s card membership base but will also help it penetrate the unexplored market and tap the upcoming opportunities in the field of eCommerce.

Although increasing regulatory compliances, low interest rates and higher expenses are weighing on the net interest income and margins, we believe the long-term outlook remains firm for AmEx. Based on the current market volatility, the Zacks Rank for AmEx currently stands at #3, implying a short-term Hold and a long-term Neutral stance.

 
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