Next week American Express Co. (NYSE:AXP) will be announcing its Q3 earnings. What should investors expect with regards to American Express Co. (NYSE:AXP) accounting practices and reserves? Ahead of the American Express (AXP) earnings announcement, CapitalCube assesses the Earnings Quality for the company based on data over the last five years.

Earnings

Today’s blog wraps up our focus on American Express Co. (AXP) for this week. CapitalCube’s earlier articles on the subject included: American Express (NYSE:AXP): Playing cards with Wal-Mart (NYSE:WMT)American Express Co. (NYSE: AXP): M&A and Dividend assessmentAmerican Express (NYSE:AXP): Two star dividend?.

Our company analysis are always peer-based. We compare AXP stock to its peers in the Financial Conglomerates sector, namely:  JPMorgan Chase & Co.(NYSE:JPM), Visa Inc. (NYSE:V), Citigroup Inc.(C), Bank of America Corp (NYSE:BAC), MasterCard Inc. Cl A (MA), Capital One Financial Corp. (COF), Discover Financial Services (DFS), and Cielo S/A (CIEL3).

Earnings Quality

Accounting Quality

American Express Co. (NYSE:AXP)-US’s net income margin for the last twelve months is around the peer median, which combined with a relatively conservative accrual policy suggests possible understatement of its reported net income.

Management of Reserves

Strong Buildup
The company’s accrual levels over the last twelve months are both positive and greater than the peer median suggesting the company is not only building reserves but is doing so in a relatively strong manner compared to its peers.

Material Categories

Excluding the effects of change in revenue, the accounting categories causing the most impact on the movement of net income from the prior period to the current period are SG&A, Accounts Receivable and Intangible Assets.

Earnings: From Accounting or Cash Flow?

Net Income = Net Operating Cash Flow – “Accruals”

Accruals are estimates by company management of non-cash expenses, assets and liabilities that are recognized before they are paid. They are calculated as net operating cash flow less net income.
The analysis of accruals can help signal possible earnings management of reported net income and EPS results. For example, ‘Over-Accrued’ can signal under reported net income and/or the building of balance sheet reserve accounts, while ‘Under-Accrued’ can signal inflated Net Income results and/or release of balance sheet reserves to aid reported earnings.

Recent trend for AXP-US’s accruals

The annual trend suggests that AXP-US’s accruals to revenue ratio continues to trend upward and is above (but within one standard deviation of) its four-year average accruals to revenue ratio of 16.5%. Though its accruals to revenue ratio has remained relatively stable at 17.3% compared to 2010, its peer median has increased to 17.3% from 16.7% during this period. Relative to peers, accruals to revenue ratio fell 0.6 percentage points.
On a quarterly basis, AXP-US’s accruals to revenue ratio continues to trend downward and is below (but within one standard deviation of) its four-quarter average accruals to revenue ratio of 24.9%. While its accruals to revenue ratio decreased to 23.2% from 26.6%, its peer median increased during this period to 21.3% from -7.5%. Relative to peers, accruals to revenue ratio fell 32.2 percentage points.
Graph of Annual Accruals (TTM) showing Peer Median for American Express Co. (NYSE:AXP)
Graph of Quarterly Accruals (TTM) showing Peer Median for American Express Co. (NYSE:AXP)

Accounting Quality

Financials suggest possible understatement of net income.

AXP-US’s net income margin for the last twelve months is around the peer median (15.0% vs. peer median of 16.4%). This average margin and relatively conservative accrual policy (23.7% vs. peer median of 18.3%) suggests possible understatement of its reported net income.
Accounting Quality or Net Margin vs. Accruals charted with respect to Peers for American Express Co. (NYSE:AXP)

Management of Reserves

AXP-US’s accounting suggests a relatively strong buildup in its reserves.

AXP-US’s accruals over the last twelve months are positive suggesting a buildup of reserves. In addition, the level of accrual is greater than the peer median — which suggests a relatively strong buildup in reserves compared to its peers.
Management of Reserves, Buildup or Drain? Charted with respect to Peers for American Express Co. (NYSE:AXP)

Key Items Impacting Cash Flow

Accounts Receivable, Intangible Assets and PP&E have the most material impact on the movement of net income.

We assess the impact of various categories on the cash flow of the company by performing a variance analysis. For each category, this variance analysis measures the movement between the current and previous periods, normalized for the size of the company (e.g. days outstanding or percentage of revenues). This normalization eliminates any movement attributable to period-by-period growth and helps isolate the impact of any accounting policy changes the company might have made in recording the values in each category.
The chart below shows the impact of the top accounting categories on American Express Co.’s cash flow for the current quarter. We consider both positive and negative impacts on the cash flow since the categories could have either decreased or increased the reported net income.
% Impact on Cash Flow for American Express Co. (NYSE:AXP)
The table below details the impact of the major accounting categories on American Express Co.’s net operating cash flow for the current quarter. While we have identified the major accrual categories, and conduct several tests on this standardized set, it should be noted that companies can sometimes have a non-standard accrual item that has a higher impact on the difference between net operating cash flow and net income.
Item Latest Quarter Previous Quarter Impact On Cash Flow (mn) Impact On Cash Flow (%)
Accounts Receivable DSO 469.4 264.3 (19,184.1) (579.6)
PPE DSO 36.8 37.9 98.2 3.0
Intangible Assets DSO 0.0 24.0 2,246.5 67.9
SG&A DSO 26.8 26.8 1.2 0.0
Tax Rate (%) 28.7 29.2 29.9 0.9
Restructuring Expense (% Revenue) N/A N/A N/A N/A