By Matt Doiron
Credit card stocks have generally done well over the last year, and MasterCard (MA) has outperformed the S&P 500 with a 22% return despite generally being somewhat insulated from economic conditions (the stock's beta is 0.8). The company experienced a 10% increase in revenues in 2012 compared with the previous year. While earnings did increase significantly in percentage terms, this is partially an artifact of a large litigation settlement in 2011. If we strip out litigation settlement items from the financials, pretax income increased by 12% - showing little changes in margin. MasterCard reported $21.94 in earnings per share for the year, and at the current market capitalization of $65 billion the stock trades at 24 times trailing earnings.
At that valuation, we'd generally expect to see a company which can grow its net income at double-digit rates for several years. We did see good earnings growth from MasterCard last year, but going forward we would question how sustainable MasterCard's growth rates are. Wall Street analyst consensus for 2014 implies a forward P/E of 18, so even if the company hits sell-side targets it will have to continue significant growth numbers from that point forward in order to justify the current valuation let alone provide undervalued.
A number of hedge funds have liked credit card stocks in the past few quarters, and MasterCard is no exception. Tiger Global, a Tiger Cub hedge fund, had MasterCard as one of its five largest holdings by market value as of the end of December, reporting a position of about 670,000 shares in its 13F (see Tiger Global's stock picks). Viking Global- managed by fellow Tiger Cub, and billionaire, Andreas Halvorsen- cut its stake by 33% between October and December but still closed 2012 with about 550,000 shares in its portfolio. Warren Buffett's Berkshire Hathaway disclosed ownership of a little over 400,000 shares, though this was a relatively small position in dollar terms for the holding company (see Buffett's top stock picks).
Visa (V) is MasterCard's closest peer. Visa's forward P/E is 19, so it is valued essentially in line with MasterCard on that basis. In its most recent quarter, which ended in December (the first of its fiscal year), Visa grew its revenue by 12% compared to the same period in the previous fiscal year- even with MasterCard's sales growth rate for the year as a whole. Visa may well be thought to have a stronger brand than MasterCard, and so possibly superior in relative terms, but we aren't particularly excited about it from a value perspective either.
We can also compare MasterCard to American Express (AXP), Discover Financial Services (DFS), and Capital One (COF). These stocks are considerably cheaper than Visa and MasterCard, though their brands are not as strong. Capital One and Discover actually trade at 10 times their trailing earnings or lower- quite a heavy discount- and in their most recent quarter financial performance was quite good versus a year earlier as well (though Capital One was aided by an acquisition). In fact, at those earnings multiples Capital One and Discover could be bargains as long as they managed any earnings growth at all in the next couple years; we would recommend looking into them as value prospects. American Express only managed to grow its revenue by 2% in the fourth quarter of 2012 compared to Q4 2011, and with a trailing P/E of 17- about square between Visa and MasterCard at one extreme, and the other two peers on the other- we don't think that it's a good stock to buy.
It's possible that Visa and MasterCard will achieve high earnings growth over the next several years and prove cheap even at their premium valuations. However, we'd guess at this point that any such rise would be led by industry dynamics, which should at least in part help Capital One and Discover as well (even though those companies do not have as positive a reputation). As a result we think that those two cheaper stocks are a better place to at least start looking for value.