MasterCard: Is the Optimism Justified?

MasterCard Incorporated (MA) reported earnings after the close Monday.  By almost all standards the company beat expectations coming in with earnings of $2.47 per share on revenue of $1.3 billion dollars.  The expectation had been for earnings near $2.25.  The third quarter was characterized by strength during the majority of the period, but management noted a sharp drop in activity mid-September after the Lehman Brothers failure.

While it is certainly encouraging that the company was able to post a strong third quarter, the key for valuing investments is not looking in the rear-view mirror but instead developing an accurate assessment of future earnings.  As such, the conference call concentrated much more on the current environment and management’s assessment of the direction of the global economy.

Management noted that October saw pronounced weakness in the United States.  This presents a significant challenge for the fourth quarter leading into the holiday sales period.  The CEO stated that Americans are cutting back on travel and spending less when they do travel which obviously cuts into the company’s domestic revenue.  On the international side, there is still revenue growth expected albeit at a much lower rate.  Even more importantly, the company is seeing “significantly reduced spending among financial institutional customers.”  These customers are focusing more on risk control by not issuing cards to consumers who have low credit scores or perceived difficulty in repaying loans.

Without a doubt, there are trends that favor MasterCard and its competitors.  Not only are developed countries beginning to see the majority of transactions take place electronically, but emerging markets are driving growth as well.  Since MasterCard does not actually extend credit to consumers, it does not explicitly bear the risk of cardholders defaulting.  Even with the current global challenges, the firm is still expecting to see revenue growth over the next year.  Management also has renewed their focus on expense control which should prop up profitability even if revenue growth is light.

However back in July, Zachstocks issued a cautious note on MasterCard as investor expectations appeared to be too optimistic.  Since that time, the stock has lost roughly 40% of its value and still looks like it could have farther to go.  At this time in the market cycle it is very dangerous to short stocks.  Even after the earnings report, MA is up 11.5% in pre-market trading.  I would not suggest shorting the stock until the market works off its over-sold condition.  However, if the stock rallies closer to the $180 to $200 range, it may present an attractive opportunity to short.  Economic weakness will likely pressure earnings more than expectations, and the current price still discounts a robust view of the company’s earnings power.

MA Notes

Disclosure: Author does not have a position in MA.

Comments

[Echo To All:]

"the current price still discounts a robust view of the company’s earnings power."

ur kidding right. With a PE of 15-17 it is trading more like an established cyclical then a growth stock.

i'm not saying it is going to rally, many stocks will be range bound, including MA. But to ignore MA's flexibility to reduce costs, and to call it expensive with a trailing PE of 15-17 as it continues to beat est. is simply wrong. ur analysis is overlooking these two key points which caused it to spike up 18% yesterday.

2008 Nov 05 09:38 AM

[who:]

With a global slow down at the minimum how would MA keeps to its pace?

People will still use their plastic as I do, just bought a 32in flat screen for my dad with plastic 24 months interest free - monthly payment of $25! But, overall spending has been mainly kept to essentials.

2008 Nov 05 11:34 AM

[kdo:]

Uh, I seem to remember Zachstocks shorting them in the $120 range. How's that original short going for you, cause that was WAY before July when they were in the $300 range. Good call Zachary. Nice to point to your call in July and miss out on the fact that MA was kicking the crap out of you for a long time.

2008 Nov 05 02:14 PM

[Zachary Sch...:]

echotoall - I am a bit concerned that future estimates may be aggressive. If that is so, your forward PE may be low. Obviously not a certainty but if the company has difficulty meeting its targets you can expect both the EPS as well as the multiple to contract. We've seen it in many other financial investments and it could certainly happen to the card processors.

Greg - you're right, its a dynamic market and there are no guarantees. I will certainly be wrong at times. From a trading standpoint when this happens you need to stop out of your position, take a step back and re-evaluate the fundamental story. Sometimes I'm just plain wrong and need to go another direction. Other times I am early and need to come back to the idea when the situation is ripe.

Thanks to all three of you for the comments!
Zach
zachstocks.com

2008 Nov 06 09:19 AM