Before the open, MasterCard (NYSE:MA) reported that Q1 earnings declined from last year but beat analyst estimates. The reason to like the company remains intact, but the reason to own the stock is still questionable.
The stock initially surged to a high of $100, but the rally quickly faded during the trading day. My predictions over the last six months have repeatedly (here and here) focused on the key resistance at triple digits and the struggles for justifying a higher price. The chart even looks like a dreaded head and shoulders at this point.
The quarterly numbers were unnecessarily messy due to some one-time costs and reversals of tax benefits from last year. The stock initially popped on the tax benefits last year and now the numbers look worse as the reported earnings show a YoY decline.
The story with MasterCard remains one of two stories. First and foremost on investor minds is the growth in transactions and the global shift away from cash payments. Second, the maxed out margins is an issue mostly ignored by investors willing to pay high valuation multiples for the stock.
The quarterly revenue slide from the investor presentation embraces the two issues perfectly. All of the revenue items show solid growth in a consistent manner that makes investors flock to the stock. The one big fly in the positive story is the surging hidden costs. The payment processors classify rebates and incentives as a reduction to revenues, but in reality this category is a cost. For Q1, incentives grew 22% on a currency-neutral basis.
The rebates and incentive costs grew much faster than the main revenue categories of domestic assessments and transaction processing fees. The end result is that net revenues grew slower than volumes.
The above method of reporting net revenues helps skew the reported operating margins, but MasterCard still generated a margin of 55% in the quarter. My investment thesis still sees these high margins as a risk to the downside with limited upside potential.
This brings the valuation discussion front and center. MasterCard and Visa (NYSE:V) are continuously valued based on the concept of payment transactions shifting away from cash while ignoring the long-term risk to the margins. In that manner, investors pay multiples far above the actual growth rates of the associated companies.
Due to quirky reporting of unadjusted numbers, MasterCard is only forecasted to grow earnings roughly $0.10 this year. Looking at the 2-year growth rate, the EPS is forecast to reach $4.13 in 2017 for a total increase of $0.70. In essence, the forecast is for 20% total growth over that period for an annual growth rate below 10%. The stock though trades above 23x those 2017 estimates.
The MasterCard forward PE multiple at 21.3x analyst estimates is lower than Visa though both stocks are nearly equally expensive.
The key investor takeaway is that MasterCard is a solid company and would be an appealing stock if trading at 15x EPS estimates. The stock though needs to trade down to $65 before value exists. For this reason, MasterCard will struggle trading above $100 in the short term.
Nothing stops the stock from surpassing this price as investors have shown a willingness to overpay for the payment processors. The recommendation though is to avoid MasterCard at prices close to $100.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.