How to Cash In on Visa and Mastercard

Includes: MA, V
by: Andy Singh

Going into the earnings season, credit card transaction processing companies like Visa (NYSE:V) and Mastercard (NYSE:MA) have been hit pretty hard due to adverse impacts of the recently approved financial reform regulation, which limits the interchange fees they can charge banks and merchants for card transactions. However, the actual regulation in the financial reform bill was scaled back to only cover debit card network fees, which impacts the banks more than it would Visa or it’s card processing competitor Mastercard.

Following the public release of the financial reform bill, Visa and Mastercard stock prices dropped nearly 20% from recent highs within just a couple of weeks. While they have recovered somewhat along with the broader market in improving and more certain market conditions, I think the stocks have much more upside going into earnings. In fact, a fairly risk free trade, albeit with a bit of initial up-front capital, is to buy the stock before earnings (see dates below) and buy put options to cover any short-term downside risk.

In particular, I think the international growth potential of Visa an Mastercard will offset any adverse impacts of the domestic financial regulation costs. International revenues and margins from foreign operations are already starting to account for a significant portion of these companies revenues, particularly from a still booming Asian economy.

Further, with the threat of another Euro-American economic slowdown for later this year, V and MA both offer better than average downside protection as shown in the past few years as the stock prices reached new highs. Thus the longer-term outlook of both these companies looks strong.

(Click to enlarge)

The table here shows the relatively simple trade I am going to be putting on for Visa (since it reports earlier) using the stock and a single put option contract (prices at COB 7/26). As you can see, the trade is to buy 100 stocks and a single August $76 put option contract (one contract equals 100 shares). If the earnings and outlook are strong, the stock price should rise to near $90 and I stand to make $1,175 (15%) within a couple of months, as analysts reassess the stock’s growth prospects.

However, if there is a negative surprise and earnings miss and/or the outlook is below expectations, the stock will fall soon afterwards, and the put option can be sold for a profit (200% return). While I will have a paper loss on the stock should it drop below $76, I will keep holding until it recovers, as I believe the longer-term outlook is still very strong.

Visa is scheduled to report its Q3 2010 results after the market closes on July 28, 2010. Analysts’ estimates for Q3 2010 range from a low of $0.87 to a high of $0.98, compared to a consensus estimate of $0.93. Mastercard is scheduled to report on August 3rd, 2010. Given Visa reports first, I am going to execute the trade above for V first. If it works, then i will make the same trade for Mastercard. I will post the results of my trade on this post after it is made.

Disclosure: No positions