Mastercard's Risks

Mastercard (MA) has been an incredible success story with a current return of over 375% from its $39 IPO price in May of 2006. The returns are largely due to the company’s aggressive expansion overseas as developing nations jump on the bandwagon of making payments with plastic instead of cash. Mastercard has been so successful with their International growth that domestic sales now only account for 45% of total transaction volume.

A falling US currency has provided quite a tailwind as these international transaction revenues are being translated to dollars for reporting purposes at very attractive rates. One could argue that a significant portion of the increase in revenue can be attributed to this currency translation which calls into question just how much of future expected earnings growth also prices in dollar weakness. As the dollar begins to find some support and may be mounting a counter-cyclical-trend rebound, investors may be caught off guard if MA revenues do not show the same increases which have previously been present due to the currency issue.

In digging up information on Mastercard, I was surprised to find out how many analysts were truly bullish on the firm. It is often tough to get a straight opinion from these sources because a big firm like MA will likely have huge underwriting needs and analysts are uncomfortable giving anything but a positive report so as to avoid disqualifying their firm for investment banking revenues down the line. The problem with this is that many large firm’s customers will be directed to buy this stock and may not be aware of the risks that are inherent with this business.

When speaking of risks, it is important to note that MA does not have material exposure to credit risk, liquidity risk, or interest rate risk. Analysts make this very clear in their reports and offer investors a false sense of security. Since these three risks are the ones most likely to pull traditional financial companies down, it is comforting to know that they are not important when discussing Mastercard. However, Mastercard bears a large amount of risk associated with a decline in consumer activity. This risk cannot be understated as US consumers are facing tighter and tighter revolving credit restrictions, and international markets are already well into a heavily reported economic boom. It seems that all the good news is on the table and the unknowns are much more likely to be negative than to surprise on the positive side.

American Express (AMX) recently issued a pre-announcement which spooked the credit card transaction sector. The company disappointed investors by citing weakness in domestic transaction levels and because of this, many transaction based companies saw their stocks get hit. Analysts quickly came to Mastercard’s rescue by stating the comparison was unjustified due to Mastercard’s international exposure. However, 45% of revenue in domestic transactions is nothing to dismiss. And we are currently seeing rising correlation levels between our economy and other emerging market economies. This may not have a long-term effect on MA’s earnings, but it will almost definitely have an effect on the valuation of those earnings. With MA trading at a nearly 20% premium to the transaction processing peers, it appears there is more risk in the stock than many analysts will let on. I would urge caution with these shares and look for other opportunities with better valuations.

Comments

[parker:]

good writeup, nice to see someone addressing downside concerns, not just a go buy this stock article. I agree...avoid until valuation looks better. Along with the analysts, CNBC's Fast Money (Guy Adami) has been rooting for this one often the last few months (stating lack of consumer exposure) as well.

2008 Jan 25 12:34 PM

[Zachary Sch...:]

hmmm - it's pretty hard to take someone seriously who does not believe MA has consumer exposure. They may not have credit or liquidity or even interest rate exposure but they most definitely fluctuate based on consumer spending habits.

Thanks for the comment

2008 Jan 25 05:45 PM

[Mr. Billion...:]

I wonder if studies have been done about changes in consumer spending with regards to credit cards. It seems people are more apt to continue a certain lifestyle out of habit regardless of their economical situation, foreclosed home, diminished portfolio, etc. It's so easy to fall into the credit trap of saying "I'll just charge it" as they try to survive hard times. Wouldn't MA benefit from all this economic downturn as people shift methods of payment?

2008 Jan 26 10:01 PM

[Zachary Sch...:]

I think you are correct in the thought that people will continue to charge when they can. However, I worry about a time when the consumer becomes so loaded down with debt that those charge cards are denied. Some anecdotal evidence I have been reading suggests that there are more and more "rejections" popping up as people reach their credit limits - this could become a much larger problem.

2008 Jan 30 03:37 PM