About the report
In this report, we will undertake an in-depth financial analysis of American Express and its core rival VISA Inc. using the 5-point Du-Pont analysis. The core objective of framing this report is to unearth the real drivers of ROE of each company, while the paper will be concluded with a recommendation for American Express to improve the sustainability in the ROE multiple.
5-Point Dupont Analysis
The 5 point DuPont system of analysis is the extended version of three-point DuPont analysis method, and just like the traditional method, it also decodes the ROE multiple of the company into function of different ratios to see what drives the ROE of the company. Below is the formula used for decomposing ROE under this method:
ROE= Tax Burden* Interest Burden* Operating Margin* Asset Turnover* Financial Leverage
= (Net Income/EBT)* (EBT/EBIT)*(EBIT/ Revenue)* (Revenue/ Total Assets)* (Total Assets/ Equity)
American Express:
ROE= 0.65* 0.26* 1* 0.22* 7.70
= 28.62%
Analysis
Referring to the calculations above, we can witness that ROE of American Express is calculated to be 28.62%, with financial leverage of 7.70 being the main driver. As for tax burden, the company faces a high tax burden with low multiple of 0.65 as while the earning before tax of the company amounted to $8,991 million, the net income plummets to $5,885 million indicating that approximately 35% of the EBT is lost in tax and tax related payments.
As for interest burden, the effect of high financial leverage is visible on this multiple as the company shares a high interest burden of 0.26 as owing to interest and related expense, operating income of $34,292 million plummets to mere $8,994 as earnings before tax.
Next, American Express earns a high operating profit margin of 100% with revenue and operating income at similar level of $34,292 million. However, the asset turnover of the company is somehow depressing with multiple of 0.22 only.
Of all the ratio multiples we calculated for the company, the most important one was the financial leverage that amounted to 7.70, indicating that American Express is using high amount of debt are used to finance the asset position, a source of worry for the investors.
VISA Inc.
ROE: 0.70* 1*0.61* 0.33* 1.41
= 19.86%
Analysis
Referring to the calculations above, we found that VISA Inc. is facing relatively low tax burden with multiple of 0.70 as the pre-tax profits of $7,724 million was also decreased by an acceptable 30% tax rate. In addition, the company has interest burden of 1.0 indicating that it don’t have any interest obligations to honor.
As for operating margin, VISA INC. has an appreciable multiple of 61% while the asset turnover is higher than that of American Express at 0.33. However, of all the ratio multiples we calculated, the most attractive one was a relatively lower financial leverage of 1.41 that confirms the sustainability in the ROE of the company.
Comparing ROE multiple
Now that we have decomposed the ROE multiple of both the companies, it is clear that although American Express have a higher ROE multiple of 28.62%, but the same is not sustainable as it is sourced from high financial leverage of 7.70 which also contributes to a high interest burden.
On the other hand, VISA Inc. ROE multiple of 19.86% is although lower than that of American Express but is more sustainable and enticing for an investors as it has been sourced from a lower financial leverage, high asset turnover, operating profit margins and most importantly a lower interest burden that that of American Express.
Recommendation
The above discussion makes it very clear that although high but ROE multiple of American Express is not sustainable as it has been sourced from high financial leverage that is a source of worry for the investors as high financial leverage was accompanied with high interest burden and increase financial risk for the company and its investors.
Therefore, it is highly recommendable that the company should work aggressively to lower its financial leverage and should look forward to enhance its asset turnover and operating margin, making them being the core driver of ROE multiple instead of financial leverage.
References
Balance Sheet: American Express. (2015, April 25). Retrieved from Morningstar: http://financials.morningstar.com/balance-sheet/bs.html?t=AXP
Balance Sheet: VISA. (2015, April 25). Retrieved from Morningstar: http://financials.morningstar.com/balance-sheet/bs.html?t=V®ion=usa&culture=en-US
Income Statement: American Express. (2015, April 25). Retrieved from Morningstar: http://financials.morningstar.com/income-statement/is.html?t=AXP®ion=usa&culture=en-US
Income Statement: VISA. (2015, April 25). Retrieved from Morningstar: http://financials.morningstar.com/income-statement/is.html?t=V®ion=USA&culture=en_US
Appendix
Refer to excel sheet
