After rallying more than 55% so far in 2013, shares of MasterCard (MA) picked up another 3% after hours thanks to several shareholder friendly announcement (available here). While the march to $1,000 has been delayed, perhaps indefinitely, should investors buy MA after its buyback, dividend, and stock split announcement?
First, MasterCard is doing a 10:1 stock split. While this could add some liquidity and make investors more interested in the stock as many don't like buying a stock priced above $700, the stock split is neither a reason to buy or sell shares. Stocks are not expensive based upon their price but based upon their valuation compared to fundamentals. MA has earned $25.30 the past twelve months and is at $763. After the stock split, it will have earned $2.53 and be priced at $76.3. Every ratio remains the same, prices and per share data just move a decimal place. An investor who wasn't a fan of MA before the split should not become bullish because of the split.
Why then did shares rally 3% on the news? I hope it is not because of the stock split but the other two announcements. First, MA is increasing its dividend by 83% to $1.10 (or $0.11 after the split). While that is a nice hike, that is still a meager 0.58% yield. With 20% EPS growth and 13% revenue growth, MA pays out a small fraction of its earnings (14% of next year's projected EPS). In total, the dividend will cost $520 million. Management would clearly rather reinvest in the business than make dividend payments to shareholders, and with the growth rates in the payment business as plastic takes shares from cash in emerging markets, I fully understand. While the yield is not compelling on its own to buy shares, I would expect continued annual hikes of at least 50% for several more years. Management will need to raise the payout by 20% just to keep the payout ratio the same, and I expect over time as MasterCard matures and slows down, a higher payout ratio will be targeted. Strong dividend hikes are a positive, even if they currently account for very little return.
Finally, MasterCard authorized a $3.5 billion buyback program that will begin when the previous $2 billion program is exhausted. $514 million remains on that program, so MA plans to buy back a little more than $4 billion in stock or 4.4% of outstanding shares. MA has $6 billion in cash on the balance sheet, so this is a significant program, though with $4.5 billion in annual operating cash flow it is certainly sustainable.
The $2 billion buyback was announced this past February, so this buyback was unexpected only 10 months later. Over the past 10 months, MA has repurchased $1.93 billion in shares, and I would expect the vast majority of the company's current authorization to be used in the next 12 months, meaning a nearly doubling of the pace. Between the dividend and buyback, MA will be returning about 80% of cash flow to shareholders in the next 12 months, which shows an increasingly shareholder friendly management.
While some investors might prefer a higher dividend, I am happy that management is devoting the majority of resources to the buyback. Management has consistently offered a bullish view of the business, and 20% expected EPS growth in 2014 is indicative of that. As emerging markets develop, debit and credit cards will be the de facto form of payment as they are in the United States. As MasterCard and Visa (V) expand into these markets, collecting swipe fees, potential growth is tremendous with the only competition, not cash, but the potential for mobile payments systems like PayPal (EBAY) on a phone. With so much growth ahead, investors will do better with a share buyback and smaller share count than a dividend.
With a growing but nascent dividend and major buyback announced, it is easy to see why shares of MA rallied after hours even with the fanfare on the stock split, which has no bearing on the company's value. These actions will provide incremental returns to shareholders while accelerating EPS growth beyond net income growth. With so much growth potential overseas, I see 20% EPS growth for MA for 3-5 years and $31-$32 in EPS in 2014. With that type of growth and market opportunity, I think a PEG ratio of 1.5x is appropriate for a 30x P/E multiple. I like MA here with upside to $950 in 2014. Even after the pop, MA has further upside, though given the massive run, I can understand waiting for a pullback.