Credit Suisse Research Analyst Moshe Orenbuch published a report titled “U.S. Credit Card - Charging Ahead in 2012; Competition Rising; Networks Better Positioned - Favor Visa” on Dec 19, 2011. The report isn't publicly available but we are going to summarize the important points. Orenbuch analyzed U.S.-based credit card companies and their current operating dynamics. The article discusses the impact of Durbin Amendment, competitive forces, economic outlook, and outlook for core business operations in order to identify best stocks for 2012. Orenbuch favors companies that are well positioned in networks and recommends Visa as the best stock in the sector.
MasterCard (MA) has been assigned with an ‘Outperform’ rating by Credit Suisse. MasterCard is well-positioned to benefit from higher spending volumes and the ongoing secular shift from cash to plastic payment methods. Net revenues are expected to increase by 12-14% for 2011-2013. Credit Suisse also expects the company to authorize additional buybacks, given strong cash flow. A target price for the stock is set at $430, which is 19.6 times Mastercard’s forward EPS. Hedge fund manager Andreas Halvorsen initiated a $240 million position in MasterCard during the third quarter.
Visa (V) is Orenbuch’s top stock pick in this sector. Visa is well-positioned to benefit from higher spending volumes and the ongoing secular shift from cash to plastic payment methods. Visa’s management expects a 10% revenue growth rate for 2012. Processed transactions are projected to increase by 13% in FY12. Visa will also continue share buybacks in 2012. The company is expected to return $1.8 billion to shareholders through repurchases and dividends, which represents around 50% of FY12’s net income. Credit Suisse has a target price of $110. Its forward PE ratio is 19, which is a discount to the pre-recession average of 22x. Stephen Mandel’s Lone Pine Capital initiated a $195 million position in Visa during the third quarter.
American Express (AXP) has been assigned an Underperform rating by Credit Suisse due to pressure on rewards and other costs as a result of increased competition in the industry. Revenues are projected to grow by 9%. CS has a target price of $40 for American Express, which corresponds to a forward PE ratio of 10. This is below AmEx’s historical average, justified by the pressure exerted by the competitive forces and a less favorable regulatory environment.
Capital One (COF) has been assigned a Neutral rating by Credit Suisse. Capital One also faces stiff competition posed by the other card issuers. Orenbuch is also concerned about integration risks from Capital One’s recent ING and HSBC (HBC) acquisitions. Pre-provision earnings are expected to grow by 38% in 2012. Loans are expected to increase by 19% in 2012. A target price for the company is set at $53, which translates into a forward PE ratio of 9. This is a slight discount to Capital One’s historical average.
Discover (DFS) is also rated Neutral by Credit Suisse. Orenbuch isn’t bullish about Discover because of the harsh competitive environment in the card business. Pre-provision earnings for the company are expected to grow by 7% in 2012. A target price for the stock stands at $30, which corresponds to a PE ratio of 9.
We think other stocks in the credit card business like Bank of America (BAC) and Citigroup (C) are not the best way to play the credit card space. These stocks are too diversified and won’t benefit as much as the stocks we discussed above. Our favorite stocks in this space are Visa and Mastercard. We recommend investors to make a diversified bet on both Visa and Mastercard.
Mastercard is the most popular credit card stock among the 350 hedge funds we are tracking. There were 46 hedge funds with bullish positions in Mastercard shares. Visa is also very popular among hedge funds. There were 45 hedge funds with bullish Visa bets. Actually, hedge funds invested more in Visa collectively than they did in Mastercard ($3.5 billion vs. $2.3 billion). Warren Buffett’s Berkshire initiated brand new positions in both Mastercard and Visa in 2011 (see Warren Buffett’s portfolio).
Disclosure: I am long C.