MasterCard (MA, Financial) delivered its third-quarter numbers on Oct. 28, 2016. Nine months into fiscal 2016, the $118.4 billion credit card company delivered strong 12.2% sales growth to $8 billion and 7% profit growth to $3.1 billion, representing a near 40% profit margin.
“We are executing on our strategy, deepening issuer relationships and delivering our customers and partners digital-first solutions. As a result, consumers benefit from seamless and secure purchase experiences everywhere and every way they shop.” –Â Ajay Banga, MasterCard president and CEO
Ă‚
As a result, the share price of MasterCard climbed up by 3.19% that day while the broader Standard & Poor's 500 index remained closed to flat with -0.31%. MasterCard is expected to deliver its full year earnings results by the end of this month.
Return
MasterCard has nearly outperformed the broader index in both one- and five-year total returns with 22.8% and 26.8% compared to the latter’s 23% and 14.5% (1).
Valuations
According to GuruFocus data, MasterCard had a trailing price-earnings (P/E) ratio of 30 times (industry median of 15), whopping price-book (P/B) ratio of 19 times (industry median 1.2) and price-sales (P/S) ratio of 11.5 times (industry median 3.6). The credit card company also had a trailing dividend yield of 0.73% with a 21% payout ratio and a 2.1% share buyback ratio.
MasterCard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments and businesses worldwide, enabling these institutions to use electronic forms of payment instead of cash and checks (2).
MasterCard processes transactions through its network in more than 150 currencies in more than 210 countries and territories. On average, MasterCard generated 39%, or $3.56 billion, of its sales from the U.S. alone.
(10-K)
MasterCard has several well-known brands, including MasterCard®, Maestro® and Cirrus®. According to the company, a typical transaction on its network involves four participants: cardholder (an individual who holds a card or uses another device enabled for payment), merchant, the issuer (the cardholder’s financial institution) and acquirer (the merchant’s financial institution).
In addition, MasterCard does not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to cardholders by card issuers.
MasterCard has concluded it has one operating and reportable segment, “Payment Solutions.” MasterCard, meanwhile, has several components of its revenue that contribute to its business development. These are domestic assessments, cross-border volume and transaction processing fees as well as other revenues.
(10-K)
Domestic assessments
MasterCard’s domestic assessment business grew 3% and contributed 30%, or $4.09 billion, in total company sales in fiscal 2015.
Domestic assessments are fees charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry MasterCard’s brands where the merchant country and the issuer country are the same.
Cross-border volume fees
MasterCard’s cross-border volume fees grew 5.6% and contributed 23.6%, or $3.22 billion, in total company sales in fiscal 2015.
Cross-border volume fees are charged to issuers and acquirers based on the dollar volume of activity on cards and other devices that carry their brands where the merchant country and the issuer country are different.
In general, a cross-border transaction generates higher revenue than a domestic transaction since cross-border fees are higher than domestic fees and in most cases also include fees for currency conversion.
Transaction processing fees
MasterCard’s transaction processing fees grew 7.7% and contributed 31.8%, or $4.35 billion, in total company sales in fiscal 2015.
Transaction processing fees are charged for both domestic and cross-border transactions and are primarily based on the number of transactions. Transaction fees include switching, connectivity and other processing fees.
Other revenues
MasterCard’s other revenues grew 18% and contributed 14.6%, or $2 billion, in total company sales in fiscal 2015.
Other revenues consist of other payment-related products and services. These include consulting, data analytic and research fees; safety and security services fees; loyalty and rewards solutions fees; and program management services.
In addition, MasterCard also includes rebates and incentives in its revenue components. In fiscal 2015, MasterCard provided $3.98 billion in rebates and incentives in deduction, compared to $3.3 billion in fiscal 2014.
On average, MasterCard had 11.8% sales and 15.6% profit growth averages in the last five fiscal years.
Legal and regulatory
There are several recent events that MasterCard mentioned in its annual filing that may or may not affect its operations.
1. In 2015, the European Union issued a statement of objections concerning interchange fees and central acquiring rules within the European Economic Area. In return, MasterCard does not expect the European Commission to impose fines if the former agrees to any business practice changes as a result.
Further, MasterCard does not earn revenue from interchange fees but may be affected indirectly; that is why MasterCard has been devoting substantial management and financial resources to the defense of interchange fees in regulatory proceedings, litigation and legislative activity (3).
2. Effective in 2015, Russia required all payment systems to process domestic transactions through a government-owned payment switch. MasterCard now processes all domestic transactions in the system.
Russia is not the only country that has effectively required this type of arrangement in payment systems processing. MasterCard indicated that countries in the Middle East and a number of Southeast Asia countries are considering the same approach.
As a result, these events could adversely affect MasterCard’s ability to maintain or increase its sales and extend its global brand in the aforementioned countries.
Similar government regulatory actions were discussed by MasterCard’s bigger peer, Visa (V, Financial), in its filings.
3. In 2015, China shared preliminary regulations related to domestic payment processing.
Accordingly, MasterCard completed several capital structuring measures in 2015. The credit card company entered a $3.75 billion credit facility under its Commercial Paper Program and a committed unsecured $3.75 billion revolving credit facility under its Credit Facility arrangement – replacing its previous facility. MasterCard had no borrowings under both programs as of December 2015. Also, MasterCard completed its euro-denominated bond issuance of 1.65 billion euros ($1.76 billion).
Cash, debt and book value
As of Sept. 30, 2016,Ă‚ MasterCard had $5.2 billion in cash and cash equivalents and $3.33 billion in long-term debt with a debt-equity ratio of 0.53, compared to 0.24 the prior year. MasterCard also had 14.8% of $17.3 billion assets in goodwill and intangibles while having a book value of $6.25 billion, compared to $6.27 billion the prior year.
Cash flow
(10-Q)
Nine months into fiscal 2016, MasterCard grew its cash flow from operations by 16.2% to $3.49 billion. In addition to its strong bottom line figure growth, MasterCard had better cash inflow from its income tax receivables, settlement due to customers and accrued expenses, compared to the prior year.
Capital expenditures, including expenses related to software, were $280 million, leaving MasterCard with $3.2 billion in free cash flow, compared to $2.76 billion the prior year. MasterCard also allocated 94.6%, or $3.04 billion, in shareholder payouts including dividends and share buybacks.
(10-Q and 10-K filings)
On average, MasterCard allocated 104% of its free cash flow in shareholder payouts in the last three recent fiscal years. MasterCard placed more than 80% of its payouts in share buybacks rather than dividends resulting in its lower dividend rates. MasterCard shares had an average earnings multiple of 29.3 times in the past three years, compared to its five-year average of 27.8 times, according to Morningstar data.
MasterCard also allocated $1.48 billion in purchases of investments, both in securities available for sale and investments held to maturity. In return, MasterCard also received $651 million in proceeds from maturities of these investments in the period.
Conclusion
MasterCard demonstrated a profitable and growing business over the years. On average, MasterCard’s sales growth figures surpassed Visa’s by 136 basis points in the past five fiscal years. In addition, MasterCard has bountiful of cash flow and strong balance sheet. As discussed earlier, the company also seemed ready for any unexpected expenses in the ensuing years as it entered arrangements in 2015.
Meanwhile, operating margin has declined a little for the half-century-old company in recent years. In review, MasterCard had an operating margin of 54.2% in fiscal 2013; it was 52.5% in fiscal 2015. This could be related to some country-specific arrangements that MasterCard had to agree with in order to keep its operations up and running minus any domestic regulatory challenges.
(MasterCard share price at $108 per share with a ttm P/E ratio of 30 times: GuruFocus data)
RBC Capital Markets’ Daniel Perlin upgraded MasterCard as its top pick and had raised its target price from $115 per share to $130, a near 20% upside from $108.7. The analyst sees strong earnings and sales growth for MasterCard and indicated that higher interest rate policies should also benefit the company.
A five-year earnings multiple average applied to MasterCard’s profit growth in recent years gave a value of $86 per share (4). This should temper the new all-time high share price target of RBC Capital Markets.
In summary, MasterCard is a hold on $108 per share.
Notes
(1) Morningstar data.
(2) Information moving forward would be from MasterCard’s 10-K and 10-Q filings, unless indicated.
(3) 10-K:
Interchange fees
If issuers cannot collect, or we are forced to reduce, interchange fees, issuers will be unable to use interchange fees to recoup a portion of the costs incurred for their services. This could reduce the number of financial institutions willing to participate in our (MasterCard) four-party payments system, lower overall transaction volumes, and/or make proprietary three-party networks or other forms of payment more attractive.
Issuers could also choose to charge higher fees to consumers to attempt to recoup a portion of the costs incurred for their services, thereby making our (MasterCard) card programs less desirable to consumers and reducing our transaction volumes and profitability.
In addition, issuers could attempt to decrease the expense of their card and other payment programs by seeking a reduction in the fees that we (MasterCard) charge to them. This could also result in less innovation and fewer product offerings.
(4) Me:
Five-year earnings multiple: 28 times
Five-year profit growth: 15.6%
Disclosure: I do not have shares in any of the companies mentioned.
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