- Looking at Mastercard's 2Q18 success and evaluating why it's still not enough to justify current levels.
- Evaluating the P/E ratio in comparison to its competitors and addressing concerns about its lack of sustainability.
- Giving the company various price target valuations based on different market environments.
- Looking into the value of the dividend.
I have been asked to write an analysis with a recommendation on Mastercard (NYSE:MA). I am a fan of banks and companies in the financial services sector; however, when it comes to Mastercard, I believe it is a little too pricey for my taste in retrospect to other companies in its sector. I am going to evaluate Mastercard's dividend, gross dollar volume (GDV), switched transactions, and credit card results to explain why, even though the results aren't bad, they aren't good enough to justify purchasing Mastercard at current market levels around $200 per share. I am going to outline why I believe Mastercard is worthy of investment at the right price, as well as why I believe its current market levels are above that price. I will outline one outlier in which I do believe MA could be worth purchasing at current market levels, however, that belief is only contingent on whether or not a said investor believes that the company will continue to trade at its above-sector-average P/E ratio. With that being said, my overall consensus on Mastercard is to hold it if you were lucky enough to get it at lower price levels, and to hold off purchasing at current levels.
Gross Dollar Volume
Mastercard did see impressive growth in gross dollar volume figures. I want to iterate again that the company is posting impressive results, but when translated to forecasted earnings down the road when compared to sector P/E ratio averages, I don't see a lot of potential for the return I'd like to see in association with the way I value companies. With that being said, Mastercard has posted 9% growth in GDV in the United States, 16% growth in the rest of the world, and worldwide growth of 14% holistically. Double-digit global GDV growth is quite impressive for a company of Mastercard's size in its sector; as it is the second largest credit card company next to Visa (V), with 191 million cardholders. While these figures are impressive, as I will discuss below, they still don't justify its current market price.
(Image Source: Earnings Presentation: Pg. 4.)
Mastercard has also demonstrated impressive growth in its switched transactions segment of its business model. The company posted 2Q17 transactions of 16,014 (in millions) and 2Q18 transactions of 18,161 (in millions), representing 13% growth from the same quarter a year ago. Double-digit growth for any company is respectively impressive, but again, I do find it intriguing that Mastercard has managed to post this level of growth. Another thing to keep in mind is that the company also posted adjusted growth figures for the impact of Venezuelan deconsolidation in both 2Q17 and 2Q18. With adjustments for Venezuelan deconsolidation, Mastercard posted adjusted transaction growth of 17%. Again, impressive numbers, but as I will discuss below in my valuation paragraph, the numbers just aren't good enough for me personally.
(Image Source: Earnings Presentation Pg. 5.)
Mastercard's credit card growth card growth is the weakest of all, but still not bad. Mastercard posted 2Q17 cardholders of 2,329 (in millions) and 2Q18 cardholders of 2,441 (in millions), representing 5% growth from the same period a year ago. With adjustments for Venezuelan deconsolidation from 2Q17 and 2Q18 their adjusted growth comes out to 7% growth. Although, Mastercard's Maestro card actually saw a decline in cardholder's, having 610 (in millions) in 2Q17 and 527 (in millions) in 2Q18. Mastercard's cardholder growth wasn't incredible, but also wasn't bad. Regardless, the growth translation to earnings and sector-average P/E ratios does not justify an investment entry price at current market levels.
(Image Source: Earnings Presentation Pg. 5.)
Why The Impressive Growth Still Isn't Enough
Mastercard's dividend situation is an interesting one. I believe MA has plenty of potential to consistently increase the dividend, and even with impressive growth. The problem I have, along with the rest of my analysis, is the current market price. At current market prices, Mastercard has a dividend yield of 0.50% with an annualized payout of $1.00 per share. The company has increased its dividend for the last six years and has a payout ratio of 15.7%. What I like is the fact that with a 15.7% payout ratio, Mastercard is providing an annualized payout of $1.00 per share. It has plenty of room to increase the dividend with a 15.7% payout ratio. What I can't stand here is the 0.50% yield. Mastercard would have to have a payout ratio of 62.8% just to have a 2% dividend yield with its market price. For those lucky enough to get into MA at lower prices have the potential to be holding a good dividend company in Mastercard with enough time. However, at current market levels, the dividend is not that attractive to me.
I am using a basic valuation method to demonstrate why I believe Mastercard's impressive historical growth and recent financial results still don't justify an investment in it at current market levels. To begin with, Mastercard is trading at roughly $200 per share and has a P/E ratio of approximately 45. While it hasn't been terribly uncommon for companies to trade at relatively high P/E ratios in today's market, the financial services industry trades at a much lower sector-average P/E ratio than 45. The financial services sector-average P/E ratio is 17.70. I narrowed that P/E ratio down and took the average P/E ratio of American Express (AXP), Discover Card (DFS), Capital One (COF), and Visa. With Mastercard included, the average P/E ratio was 26.35; without Mastercard the average was 21.69, thus, I took the average between the two to get an approximate average of 24.
Considering Mastercard has beat earnings forecast expectations in the last four quarters, I decided to give it the benefit of the doubt when looking at future forecasts. NASDAQ forecasts Mastercard to have FY20 earnings of $8.81 per share. When looking at the last four quarters, Mastercard has beat NASDAQ's forecasts with an average surprise factor of 9.57%. If I apply that surprise factor to its FY20 forecasted earnings, the company would post FY20 earnings of $9.65 per share. I generally believe companies in the same sector with an equal level of competitive edge to its peers will trade at similar P/E ratios. When it comes to Mastercard, its main competitor is Visa, which not only has significantly more cardholders, but also trades at a lower market price and P/E ratio. Visa also has a higher dividend yield.
As stated above, the average P/E ratio for the largest credit card companies is 24. With that earnings multiple, and a generous FY20 estimate of Mastercard's earnings coming in at $9.65 per share, the company will theoretically trade around $231.60 per share by the end of FY20. That would represent a return of roughly 15.5% in 2.5 years, and a CAGR of just over 5%. While some investors may not think this level of return is terrible, it's not as good as I would personally like to see. Also keep in mind this level of return is based on companies in specifically the credit card sector trading at a relatively high P/E ratio of 24, on top of the fact that the earnings estimate I used is generous. I would not be surprised if Mastercard grew at a CAGR under 5%, and would say it's even possible that its market price could go down.
The fundamental behind my caution with Mastercard comes from the fact that while it has posted impressive results and beat earnings forecasts, the market price is still too high for me to justify purchasing now. I like the growth it's demonstrated, and it's always great to see a beat in earnings surprise, but even with all of that, MA is still trading at a P/E ratio of 45; considerably higher than competitor averages. Even with its growth and applying an earnings surprise factor of nearly 10%, MA would only appreciate by 15.5% in 2.5 years if it trades in line with its competitors' average P/E ratios. So, while I believe that Mastercard has demonstrated great success and results, I believe the company, and its early buying shareholders, have already been quite generously rewarded for such performance. I am putting an FY20 price target of $231 per share on Mastercard based on this valuation.
If a 15.5% return over 2.5 years, representing a FY20 market price of $231 per share, is sufficient for the readers of this article, I would recommend purchasing MA at current market levels. If you purchased Mastercard under current market levels, I would certainly recommend holding onto it. If a 15.5% return over 2.5 years does not seem too favorable, I would recommend looking into other securities with more capital gain and dividend potential.
The Outlier Valuation
The main principle surrounding my caution with Mastercard is the fact that it is trading at a much higher P/E ratio than its competitors without any kind of substantial competitive edge to justify the higher P/E ratio. However, the one outlier that I haven't entirely addressed is the fact that it is possible for Mastercard to continue trading at the current P/E ratio of 45. If this is the case, MA would trade at a FY20 market price of roughly $396.45 per share, and that is with the forecasted earnings of $8.81 per share, not my generous estimate of $9.65. For investors or individuals that believe that Mastercard will continue to trade at a P/E ratio of 45, clearly a buy recommendation would be warranted as that market price would nearly represent a 100% upside in 2.5 years. I, however, do not see this being the case, but figured I would include this outlier.
Overall, I believe Mastercard has posted quite impressive results when it comes to the gross dollar volume growth, switched transactions growth, and cardholder growth. I think the management is impeccable. I believe it is absolutely worth an investment at the right price, probably anything under $175 per share. However, at current market levels combined with Mastercard's extremely high P/E ratio in comparison to competitors, lack of significant competitive edge, unimpressive dividend at current levels, and earnings forecasts that don't paint a growth picture that I am personally looking for, I would not recommend purchasing it at current levels unless you're okay with a CAGR of roughly 5% or maybe less. Based on the average P/E ratio of credit card companies and Mastercard's earnings forecasts, I believe MA will trade around $231 per share by the end of FY20 unless it can sustain its extremely high P/E ratio. My general consensus on Mastercard is to hold onto it if you purchased at lower prices, and to look to other securities with higher upside potential if you were considering investing in MA at current levels. I will also say I would recommend purchasing Mastercard at a market price lower than $175 per share.
This article was written by
Analyst’s 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.
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