TMFDeej (99.46)

How to make money on a company that's run by idiots and resides in a terrible sector

April 13, 2009 – Comments (7) | RELATED TICKERS: AMX

Want to know how to make money on a company that's run by idiots and resides in a terrible sector?  No the answer is not to short the stock.  In many cases, it's too late for that now.  Shorting many of the companies out there at this point is like picking up nickels in front of a steamroller as the old saying goes.

The answer is to buy its bonds.  The beauty of corporate bonds is that the companies that unlike common stock you buy bonds from don't have to thrive and grow in order for investors to make money, they just have to survive.

So what terrible sector am I talking about?  Credit cards.  I have been bearish on credit cards for a long time.  I've ridden Capital One (COF) down a whopping 66.12% and Discover (DFS) down 53.51% in our beloved game so far and I continue to be bearish on their common stock. 

The company that I bought corporate bonds from is American Express (AXP).  The bullish piece on the company in this week's Barron's extols the virtues of AXP's management, but I'm not buying it.  The company had a beautiful thing going, only giving credit cards to the cream of the crop and not even really extending them much in the way of credit because it required most cardholders to pay off their balance every month.

So what did they do, like so many other companies out there they got greedy.  Right into the teeth of the worst recession in decades AXP management decided to forsake what made them such a successful, well-regarded company and ramp up its credit risk by letting more people carry balances and pushing cards on anyone who had a pulse, including a focus on people with multiple mortgages which lead to a large number of cards being issued to residents in the devastated states of California and Florida.  Oops.

AMX management certainly doesn't leave me feeling all warm and fuzzy and I certainly don't like credit card companies yet, but I say who cares.  American Express will survive this mess.  As long as it survives, its corporate bonds are a good bet...provided they have a decent yield.  A few months ago I purchased its corporate bonds that yield 5.7% and expire on 09/15/11 with a yield to maturity of around 7.5%. 

Now I realize that a 7.5% annual return isn't exactly going to light the world on fire, but this is a pretty darn safe bet.  What are the odds that AmEx doesn't exist in September 2011?  Not very high.  Better yet, I only had to tie my money up for a little over two years so I'm fairly protected if massive inflation does rear its ugly head and/or if interest rates do head a lot higher.  Besides, investors in common stock over the past several decades would have killed for a seven and a half percent annual return and the yield is certainly a lot better than the yields that are available on other things out there like Treasuries, CDs, savings accounts, etc...

So how am I so sure that AMX will surive for the next two years when the securitization market that it has tapped for much of its funding in the past may be permanently broken?  The answer Uncle Sam.  There's nothing like riding the government's coattails in investing.  Doing so has worked well for savvy investors like PIMCO's Bill Gross for a while now.  American Express has already received $3.4 billion in funding from the government's Troubled Asset Relief Program and another $5.9 billion from the Temporary Liquidity Guarantee Program (TLGP)

AmEx has access to another $7.4 billion through TLGP, $13.7 billion from credit lines with various banks, and around $25 billion in cash and "marketable" securities (yeah, I know that most things aren't that marketable right now).

This money should easily cover AmEx's needs for the next year.  If it continues to have problems, it still has room to cut costs elsewhere like pulling the plug on its $200 million per quarter common stock dividend program. 

Even though it has been somewhat tarnished in some people's eyes, the American Express name still carries a tremendous amount of brand equity.  It can use this reputation to help it get new money to survive.  The company has also rolled out a new certificates of deposit program in an effort to get funding from retail investors.  It has pulled in a whopping $8.8 billion dollars through this program since it rolled it out last fall.  The company plans to expand this program this quarter by advertising it using direct mail and the Web.

Well, that's why I bought AmEx corporate bonds in a nut shell.  I apologize for any typos, but I don't have any time to proof my work this morning.  By the way, I wonder who this Frost character whose name I always see printed on the bottom on sample AmEx cards is.

Deej