Should You Buy Mastercard Stock?
Mastercard Introduction
Mastercard is a payment technology company that generates revenue by charging fees to its customers based on both the dollar volume of card activity and the number of transactions processed through the network. It generates most of its revenue mainly from the United States. Should you buy Mastercard stock? Between Visa and Mastercard, Visa is the bigger brother in terms of market capitalization.
Today’s post is written by Chris Lee Susanto. This year, I spent more time interacting with Chris and I found that both of us have a complimentary style of investing. Both of us invest in US stocks and options. I also like his articles a lot.
More on Chris:
Chris Lee Susanto manages a U.S. stocks six-figure portfolio making 21.56% annually (capital gains + dividends + options premiums) (tracked starting from 1 March 2015 on a quarterly basis). Today, he is focusing on achieving Alpha consistently and running the Re-ThinkWealth Online Academy VIM Club well. The above stock analysis on Mastercard is an excerpt from the February premium value investing newsletter he publishes every month for his VIM Club members. He runs a blog at https://www.re-thinkwealth.com/.
Mastercard Profitability
Mastercard is launching a new global marketing campaign in which the name I really like, it is called Start Something Priceless.
“Start Something Priceless is a call to action at a time when people expect actions, not just ads, from brands,” said Raja Rajamannar, chief marketing and communications officer at Mastercard.
“This is a time when people truly believe in their power to fuel change, and whether big or small, an action has the ability to make the world a better place. That movement is what we aim to unleash this year,” Raja said.
In comparison, the latest campaign that Visa created is called The Future We’re Working On.
I personally think Mastercard’s campaign name is catchier (that is just my opinion, what do you think?).
But both ad clearly wants to position themselves as not just a card company – but something bigger than that.
And for companies like Mastercard and Visa, campaigns are a big part of their customer retention and acquisition strategy due to the mass use of their processing system by the world population. Mastercard’s ability to grow their business further is influenced by people’s consumption through electronic forms of payment instead of cash and check transactions.
The more people pay electronically through their platform, the more they will earn. So the future growth of electronic payments adoption in the world matters a lot for Mastercard.
Mastercard’s earnings per share (eps) over the past 10 years has been consistently going up except for the recent drop in 2017 to $3.643 in December 2017. The reason for the drop in earnings per share for Mastercard was because they booked $998 million in charges primarily due to the U.S. tax reform. Other than that, their revenue jumped 20.2% to $3.31 billion during that period.
The increase in revenue was due to a number of reasons: outside U.S. cross-border volumes rose 22.4% on a U.S. dollar-converted basis in the fourth quarter and growth in the overall U.S. economy over the 4th quarter helped them to generate more revenue.
Overall for the past 10 years, Mastercard has benefited a lot from the growth of online shopping. The payment processing system in online selling companies such as Alibaba or Amazon usually has a Mastercard paying option too. Although now they are facing threats with companies having their own payment transactions system like AliPay or Apple Pay.
Over the past 5 years, their eps have grown at a compounded annual rate of 10.76% annually from $2.185 in December 2012 to $3.613 in December 2017. The growth of 10.76% annually over the past 5 years is slower than the growth for the last 10 years. This is a problem and looking at Mastercard’s price to earnings ratio, it will paint us a nice picture of the market’s expectations.
Their price to earnings ratio paints a different picture with it going up on a trailing twelve months basis. Usually, a high pe ratio would mean that a high future expected growth is expected. At a pe ratio of 46.61, it means that Mastercard would need to grow 46.61% a year just to have a price to earnings growth ratio of 1 – which simply indicate that it is fairly valued. But over the last 5 years, its growth is merely 10.76%.
Mastercard’s return on equity may seem high at 70.39% but debt fuels it. Its ROE is artificially increased because of the increase in debt as you can see from its rising debt to equity ratio at the image above. Another evidence is that the return on assets is going in a downward trend as its return on equity is on an upward trend. This divergence is a sign of an artificially increased roe.
With a higher injection of debt, naturally, Mastercard have a higher return on equity because the equity denominator does not change as much as the (debt-fuel) net income growth.
Mastercard Balance Sheet
Apparently, Mastercard has higher current liabilities as compared to non-current liabilities.
As you can see, they have a 5 year high of current liabilities of $8.793 B. These are liabilities which needs to be paid off within the year. Also, this is the huge chunk of debt which artificially increased Mastercard’s roe. But it seems to be the case with card processing companies/banks in general.
Fortunately, if we look at their net income and total long-term debt, Mastercard seems to not have any problem paying off it with its net income in less than 2 years.
What worries me is their huge amount of current liabilities.
Mastercard Management
This image belongs to Mastercard.
Mastercard CEO is Mr Ajaypal Singh Banga. He has held the role since 1 July 2010.
Ajaypal started his career with Nestle in India as a management trainee and spent 13 years there.
When he was already Mastercard CEO in 2014, he was named annual best-performing CEO by Harvard Magazine. He was the only indian-origin person in that magazine. He has a good reputation in the media stream as someone who is very wise and he often gives advice to people too.
Here is Ajay’s take on taking risks in our life and here’s his six lessons on leadership.
He has no history of scandals.
Mastercard Growth
With Ajay origin being back in India, it gives him a hometown advantage in terms of expanding Mastercard’s business to India.
On October 2017, Ajay said that Mastercard is working closely with government and corporations across the world. Specifically, he mentioned that India market is ready to reduce the 95% dependence on cash for payments because of the investment it has made in Aadhaar.
Aadhar is an Indian government program which gives all its residents a 12 digit unique identification number based on their biometric and demographic data. It has 1.19 billion holders as of 30 November 2017.
Mastercard Competitors
After knowing what Mastercard is like as a company, we shall shortlist 2-3 competitors to benchmark. Preferably, I want the competitor to be in the same industry which got to do with payment processing.
The potential competitors’ list that I have screened through before shortlisting the chosen competitors are these companies: Visa, Paypal, American Express, Capital One and Synchrony financial. After reading through their websites and annual reports, I decide to choose Visa and Paypal because both of these companies are more closely related to processing payments via online (linked to online shopping and more relevant for Mastercard).
In terms of profit margin, Visa and Mastercard is head to neck. Although over the past 5 years, Visa tends to have a higher profit margin than Mastercard. As for Paypal, it consistently posts lower profit margin relative to Visa and Mastercard since 2015 when it was listed.
Paypal is the least leveraged out of the 3 companies. With Mastercard being the one with the highest amount of debt based on their debt to equity ratio. This is not a good sign.
Using PEG ratio as one of the indicators of over or undervaluation comparing their current PE ratio and past growth rate, all 3 companies are overvalued as their ratio is above 1.
Mastercard Valuation
This work is prepared by RWOA.io
The above image shows the respective multiples valuation for Mastercard’s chosen competitors – namely Visa and Paypal – two very relevant company to compare for their valuations.
These two competitors’ multiples are the basis for our multiples comparison to gage Mastercard’s under or overvaluation.
So, should we go for enterprise value or equity value multiples?
We should use enterprise multiples if we are comparing companies with different capital structure – which means that if some companies have more debt than equity with a huge divergence
That is because enterprise valuation is independent of capital structure so its is good for comparing different companies with different capital structure. Otherwise, we could have used equity valuation such as price to earnings ratio.
Debt to equity ratio is calculated simply by taking a company’s long-term debt and divide it by its total shareholder’s equity.
Visa debt to equity ratio is 0.561, Paypal’s 0.063 and Mastercard’s 0.992.
There is a slight divergence between the three debt to equity ratio. To value them, let’s go with price-to-earnings-ratio comparison. Mastercard’s current trailing twelve months price to earnings ratio is 47.79.
This work is prepared by RWOA.io
The dotted line above is the current equity value of Mastercard of about $189B.
As you can see, Mastercard is relatively overvalued as compared to its competitors as it sits right around the middle of the minimum and the maximum of its competitors’ price/TTM earnings but leaning more towards the maximum.
Looking at the absolute figure of their pe ratio which is in the range of 40 and above, it is too expensive for my liking.
Mastercard has a downside potential from its stock price at $175.76 (as of 24 January 2018) of about 3.12% if we are targeting its median and mean of its competitors. That means a potential target price of $170.27 by targeting the median and the mean of its competitors.
Mastercard Conclusion
Does Mastercard have a competitive advantage? Mastercard indeed has a competitive advantage in terms of its branding that exudes trust when handling payments that involve money. This is important. A new company that just started will find it hard to compete in terms of branding with Mastercard who have been in the industry for so many years. So branding that exudes trust is the first one – we would not want to trust a shady brand to facilitate our transferring of money. The second one is high switching cost – it is relatively cumbersome to terminate our current payment processing provider and switch to a new one. Especially if we are already using them for a long time.
What are the risks with regards to this potential investment? The price its stocks is currently trading in the stock market. Not only that it is above its peers’ mean and median multiples, its peg ratio is above 1. This is a cause for concern as there may not be sufficient margin of safety for me in this investment.