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In this article I look at Mastercard Incorporated's (MA) current valuation based on guidance provided with the release of Q2 and YTD 2019 results on July 30, 2019.
Summary
- Mastercard is an extremely high quality business with a superior business model that results in significant profits and Free Cash Flow.
- MA’s growth will come from growth in the core business, the diversification of the customer base, and the building of new areas of business.
- Ample growth opportunities exist globally.
- MA’s share price has pulled back ~9.5% from its recent high and given the current macro-economic environment I expect a further pullback.
- I do not expect MA’s valuation to retrace to what I consider an ‘extremely attractive’ level and would be prepared to pay a bit of a premium to acquire shares which I would end up owning for the very long-term.
Introduction
In previous articles I have indicated that I try to identify:
- industries with attractive long-term prospects;
- the industry participants which I think show the greatest long-term potential.
I then look at whether those industry participants are reasonably valued. Depending on my analysis I either acquire additional shares or place these companies on my ‘watch’ list.
This brings us to the payments industry wherein I have identified Visa Inc (V) and Mastercard Incorporated (MA) as the 2 companies in which I want to hold a position; shares in both companies are held either within the FFJ Portfolio and/or in accounts for which I do not disclose details for confidentiality reasons.
In my October 30, 2018 MA article I disclosed that I had acquired additional shares for ‘side accounts’ within the FFJ Portfolio.
Subsequent to that article, MA’s share price appreciated considerably to the extent where I deemed them to be overvalued; I wrote articles which can be accessed here and here. In fact, in the vast majority of my articles written in recent months I have cautioned that valuations were becoming elevated and investors would be well advised to prepare themselves for a broad market pullback.
What interesting times we live in!
Now we have MA trading at ~$257 versus ~$283 as recently as the last week of July!
This pullback has certainly been to my advantage as I wrote October 18, 2019 $250 calls against a portion of my MA shares. Until recently, these contracts were well underwater but now the current market price is just slightly above my strike price.
With the recent pullback in MA’s share price and the July 30, 2019 release of Q2 and YTD results, I take this opportunity to revisit MA.
Growth Opportunities
On the July 30th Q2 Earnings Call with analysts, senior management indicated MA continues to drive double digit volume and transaction growth across most of its markets by successfully executing against its strategy (growing the core business, diversifying the customer base, and building new areas of business).
MA continues to grow across its credit, debit, prepaid and commercial products and acceptance is being expanded across both physical and digital channels. Examples of MA’s recent successes can be found here.
On the business debit card front, MA signed an agreement in the UK with Nationwide. Nationwide plans to launch a new business banking proposition to over 5 million small businesses in the UK in early 2020.
In Colombia, MA won an exclusive debit partnership with Scotiabank, and secured long-term debit agreements with Bancolombia and Davivienda, the two largest debit issuers in the country.
In Germany, MA extended its long standing partnership with the German savings bank group, Sparkassen.
On MA’s secure remote commerce (SRC) initiative, MA is currently testing SRC with issuers and merchants and is actively working on SRC upgrades with partners such as tickets.com, Expedia Group, Saks Fifth Avenue and Norwegian Cruise Line.
MA has also developed a digital wellness program which will provide merchants with access to a host of technologies and resources, including a standard compliant click to pay checkout. Most importantly, MA is adding security through tokenization and AI technology along with cyber security resources to combat online attacks. MA is currently working with payment processors and platforms, such as Worldpay, Square, Adyen, and Stripe and also with its own Mastercard payment gateway services.
MA also continues to diversify its business by expanding across new geographies and customers.
In the fintech space, for example, MA has established a series of successful partnerships with fintechs globally. In Q2, MA signed a deal with Railsbank to bring new consumer and commercial debit card programs to market in the UK. In Brazil, MA is working with digital bank, BanQi and Via Varejo to offer a new digital prepaid card targeting ~60 million customers.
Another area of growth is building new areas of business.
MA recently announced a partnership with P27 Nordic Payments Platform, owned by six of the largest banks in the Nordics, to provide a leading edge real time and batch multi-currency payment platform across the region.
MA also continues to build additional depth and scale in its cross border capabilities, which already allow MA to disperse payments across bank accounts, mobile wallets and cards, all through a single API. In early July 2019, MA completed the acquisition of Transfast, which will enable MA to reach over 90% of the world population and will also provide a suite of leading compliance, assets, messaging and licensing capabilities to address many of the cross border pain points that currently exist.
MA is also executing on its Canada/US cross border strategy through a new partnership agreement with Interac in Canada where MA’s Send push payment capabilities will be leveraged to allow Canadians to send money internationally across Interac’s e-transfer platform. The National Bank of Canada will be the first issuer to launch this new international remittance solution.
MA is also developing new capabilities to penetrate the bill payment space. It recently completed the acquisition of Transactis to accelerate MA’s market strategy for the MA bill pay exchange.
On the B2B front, MA announced a partnership to integrate its Mastercard Track with the OpenText Supplier Portal that has buyers and suppliers in the automotive industry, streamline and digitize financial supply chain processes to increase the speed, compliance and security associated with business information, payments and financing.
Q2 and YTD 2019 Financial Results
MA’s July 30th Q2 and YTD Earnings Release can be found here and its Earnings Presentation can be found here.
FY2019 Guidance
Management’s expectations for 2019 are consistent with prior estimates. It continues to see healthy consumer spending but some moderation versus the prior year is expected; a high level overview can be found on pages 12 and 13 of the Q2 Earnings Presentation.
On the revenue front, on a currency neutral basis and excluding acquisitions, MA continues to expect to growth in the low-teens for the year.
In Q3, management expects growth in the low-teens rate with some moderation of services growth versus a very strong Q2.
Operating expenses are expected to grow at the high end of high single digits for the year.
In Q3, growth in the mid-teens is expected versus a year ago. This is due to the timing of marketing spend, which is more heavily weighted to Q3, as MA promotes contactless usage and invests in sponsorships.
Valuation
At the time of my October 30, 2018 article MA had reported diluted EPS and adjusted diluted EPS for the first 3 quarters of FY2018 of $4.73 and $4.94 respectively; comparable results for FY2017 were $3.43 and $3.44.
I indicated that in Q3 MA had generated $1.82 of diluted EPS and $1.78 of adjusted diluted EPS and conservatively estimated that MA would generate $1.80 in diluted EPS and $1.76 in adjusted diluted EPS in Q4 thus giving us FY diluted EPS of $6.53 and FY adjusted diluted EPS of $6.70.
Using the October 30th closing stock price of ~$187.75 I arrived at a forward PE of ~28.75 and a forward adjusted PE of ~28. These levels were ever so slightly lower than the 5 year average PE of ~29.
On January 31, 2019 MA reported FY2018 diluted EPS of $5.60 and adjusted diluted EPS of $6.49. On that date MA’s share price closed at $211.13 thus giving us a diluted PE ~37.7 of and an adjusted diluted PE of ~32.53.
On July 30, 2019, MA reported that it had generated $3.80 in YTD diluted EPS and $3.66 in YTD adjusted diluted EPS with $2.00 in diluted EPS and $1.89 in adjusted diluted EPS having been generated in Q2.
Based on management’s FY2019 guidance I am estimating that MA will generate ~$7.75 in FY diluted EPS and ~$7.62 in FY adjusted diluted EPS. Using MA’s share price of $256.84 as at August 5th we get a forward diluted PE of ~33.14 and a forward adjusted diluted PE of ~33.71.
While certainly an improvement from late July when shares were trading above $283, I still view MA as being a bit rich for my liking.
I would be prepared to acquire additional shares at the ~$230 level and with my projection of ~$7.75 in FY2019 diluted EPS this would result in a diluted PE of ~30. This is by no means a low valuation but with MA’s wide moat, its competitive position within the current global electronic payment infrastructure, and the ongoing shift toward electronic payments, I am prepared to pay a bit of a premium to acquire MA shares.
Credit Ratings
Moody’s rates MA’s unsecured long-term debt A2 and S&P Global rates it A+. S&P Global increased MA’s rating one notch on November 20, 2018 (subsequent to my October 30, 2018 analysis).
Moody’s rating is the middle tier of the Upper Medium Grade category and S&P’s rating is one notch higher.
MA’s credit risk is satisfactory for an investor such as me who has a low tolerance for risk.
Dividend and Dividend Yield
MA’s dividend history can be found here and its stock split history can be found here.
MA will be distributing its 3rd quarterly $0.33 dividend on August 9th and I expect the 4th quarterly dividend of this value to be distributed in mid November.
Following the payment of the 4th quarterly $0.33 dividend I expect the next 4 dividend payments to be $0.36. At $1.44/year this would still result in a sub 1% dividend yield based on the current $256.84 share price. Needless to say, investors focused on dividend yield will likely pass on MA.
The $1.44/year dividend I have projected should be well covered by Free Cash Flow and my FY2019 estimates of ~$7.75 in FY diluted EPS and ~$7.62 in FY adjusted diluted EPS.
As at FYE2008 the Diluted weighted-average number of shares outstanding was ~1,301 million shares.
As at the end of FY2015, FY2016, FY2017, and FY2018, share count was 1,137 million, 1,101 million, 1,072 million, and 1,047 million. As at June 30, 2019? 1,028 million!
Final Thoughts
Much like V, I view MA as a company in which you invest for the very, very long-term. Having said this, I am not about to invest in a great company when I view it as being excessively overvalued.
Earlier this year I viewed MA as overvalued and opted to write out of the money covered calls. Subsequent to writing the contracts, MA’s share price proceeded to rise steadily to the point where the share price far exceeded my $250 strike price.
Despite the recent pullback in MA’s share price I think MA is still a bit rich. Given the current macro-economic environment I am cautiously optimistic MA’s share price will pullback further.
I recognize and appreciate that MA’s valuation will rarely reach what I deem to be ‘attractive’ (ie. low 20s or lower). As a result, I am prepared to pay up and would look to acquire additional shares at $230 or less.
I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long MA and V.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
