Monday, 7 November 2011

Smart Investors Are Switching to Plastic: MA, V, AXP

If consumer sentiment soured last quarter, it appears that MasterCard (MA) cardholders were curiously immune. Earlier this week, the company announced third-quarter revenues were up 27%, and the dollar volume of purchases made using MasterCard-branded credit and debit cards rose 18%. Earnings per share were up an almost mind-blowing 43%. Not bad, given that we might technically be in a recession. MasterCard’s results followed stellar (if slightly more modest) results from rival Visa (V). For the quarter ended September 30, Visa earnings per share were up 20%. Most companies would kill for 20% EPS growth; only when compared to MasterCard does it look a little shabby.

American Express (AXP), MasterCard and Visa’s smaller rival that caters primarily to business customers, reported earnings last month. Earnings per share were up 14% for the quarter. Again, not bad given the condition of the economy.

Figure 1: MasterCard, Visa, and American Express

Not surprisingly, all three card stocks have enjoyed a healthy rally this year. MasterCard is the clear winner, up nearly 70% year-to-date, but Visa too has had a nice run. Both of these stocks had been held back by uncertainty surrounding the implementation of the Dodd-Frank Durbin Amendment’s restrictions on debit card swipe fees. (American Express was unaffected, as the company issues only credit cards and not debit cards.)

In lumping American Express with MasterCard and Visa, we’re not quite comparing apples to apples. AmEx actually makes loans and accepts credit risk. MasterCard and Visa do not; they simply allow banks to issue credit cards branded with their logos, and the issuing banks accept the credit risk. MasterCard and Visa also get a significant amount of their revenues from debit cards; American Express does not.

So, while I consider America Express “safe” in that its clientele tends to be high-quality borrowers, without a debit card business I consider the company’s growth to be limited. Thus, we’ll focus only on MasterCard and Visa.

Some of the rocket-like outperformance of these stocks this year was thanks to the Durbin uncertainty being lifted (note the vertical spike in both MasterCard and Visa in late June after the Fed’s favorable ruling), but there also are two powerful tailwinds supporting these companies:

  • The macro move towards a global cashless society.
  • The rise of the emerging-market consumer.
Yes, I realize the world will never truly go “cashless.” Many shoppers appreciate the anonymity of paying with cash, and cash in some physical form probably always will be with us. Still, the percentage of transactions settled with “plastic” or through other electronic means grows every year, and the continued growth of Internet commerce will only speed this along.

By some estimate, as much as 40% of transactions in the U.S. still take place with cash or paper checks, and the percentage is significantly higher in most emerging markets. Suffice it to say, MasterCard and Visa will have healthy demand for their credit and debit cards for the foreseeable future, regardless of what happens to the economy. If retail sales were to experience zero growth in the years ahead, MasterCard and Visa would be able to enjoy at least modest gains purely from consumers switching to plastic from cash or checks.

MasterCard and Visa also are well positioned to profit from the rise of the new emerging-market middle class. Visa gets close to half of its revenues from outside the United States, and MasterCard gets more than half. Much of this is from the fast-growing economies of Asia, Latin America and the Middle East. Expect to see these percentages rise in the years ahead. While the U.S. and Europe remain mired in a cycle of debt deflation, emerging markets continue to grow, and millions of people formerly trapped in poverty join the ranks of middle class consumers every year.

Neither MasterCard nor Visa are “cheap” in strict value-investor terms; the companies trade at 17 and 16 times their respective 2012 earnings estimates. Still, this slight premium is worth paying for two high-quality, high-growth companies supported by long-term trends.


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