RD's Picks

I don't hold this one in SLO or real life and hadn't really looked at it until the contest question came up. I was going to pass, but thought it was worth a quick evaluation to see if it should join the team.

The first question I wanted to answer was how they make money. I know, seems like a dumb question, it's Mastercard we all know what they do. But there are several ways financial firms make money off credit cards; interest, annual fees, branding arrangements, transaction and processing fees, ATM fees, etc. and it's important to know who's doing what to evaluate the risks involved. MA's bread and butter is transaction / processing fees. Everytime someone charges a purchase on a Mastercard, MA gets a little slice of the purchase. The banks, credit unions, etc. that issue the cards collect the interest and other fees and assume the risks that go with extending credit to all of us consumers - priceless business model.

Ok, they've got a great business model. Not much risk since the card issuers are the ones actually extending the credit. Reliable source of income, millions of people Mastercharging stuff every day - and every swipe is a cha-ching for MA. But is the stock a good buy? At market close on 28 Sep, MA was trading at nearly 25 times next year's earnings estimates - well above the S&P 500. Analysts estimate the five-year earnings growth rate at about 18%, also above the market. The nearest competitor is Visa, but they're privately held so we don't have comparable metrics. The next closest competitor is American Express. AXP isn't a great comp since they do a lot more than issue cards, but it's what we've got. AXP trades at a little over 15 times next years earnings estimates, a slight premium to the S&P. AXP's estimated five-year growth rate of a little over 12% is also quite a bit lower than MA's. Comparing the trailing PE to growth rate, or PEG, ratios of the two companies, MA comes in at 1.6, AXP at a more reasonable 1.38. Tough call between these two, MA deserves to trade at a premium to AXP and it does. But, I think AXP is a little better deal at these prices.

Other
I'm not sure Mastercard can sustain an 18% annual earnings growth rate going forward. Nearly everyone in the US already has and uses credit cards, so it doesn't seem like growth here can outpace overall economic growth by very much. If anything, consumers may pull back a little as the US economy slows.

There are tremendous opportunities for growth in the rest of the world, but I don't know if it's enough to hit the earnings targets. It's also conceivable the European, Chinese, Indian or other foreign banks could develop competing credit card processing systems. I doubt those economies are going to sit still and watch a few percent of every transaction head for the US. For this SLO exercise, I haven't spent the time to research what, if any, competition MA might face overseas. At a minimum, Visa will be in the mix.

Visa is expected to come public soon. At this point, MA is the only publicly traded, pure-play credit card processing company. When Visa comes public, the supply of stock in this area goes up. Econ 101 tells us what happens to price when supply goes up.

Summary
MA is a great company with an awesome business model, but I think it's fully valued at the current price of about $148. Given a projected growth rate of 18%, I would want to see the forward PE ratio pull back to the 20 - 22 range before I'd consider buying. That would equate to a buy price range of $120 - $132 per share. This is a popular stock and prices could run. If I owned it, my sell target would be in the $160 - 165 range. It's a great company, but at this price I think there are better buys in the market.

Comments: View Comments |  Sunday September 30, 2007