Mastercard (NYSE:MA) shares are heading towards a new 52-week high, continuing a multi-year compounding journey, which has generated a 2.9x return in the last 5 years (since the end of 2013). MA shares are now trading on a 36.3x LTM P/E. However, we believe MA shares offer an example of how "growth" has beaten "value" and continue to be an attractive investment.
MA Share Performance vs. V, AXP, & S&P 500 (Last 5 Years)
Source: Bloomberg Markets (29-March-19).
MA shares have massively outperformed fellow card company American Express (AXP) since the end of 2013, returning 2.9x vs. AXP's 1.3x (including dividends). This is despite MA having started with a far higher P/E multiple, with MA at 32.0x vs. AXP at 18.6x as of 2013 year-end (as shown below). During this period, AXP's P/E multiple has in fact contracted by nearly 4x to 14.9x, while MA's has expanded by more than 4x to 36.3x.
Comparison of EPS, Share Price, & P/E - MA vs. AXP (2013 Year-End to Latest)
However, changes in valuation multiples have only played a minor role in MA's outperformance. Most of the return in MA shares since 2013 year-end has come from earnings growth, with its EPS nearly tripling from $2.61 to $6.49 (see table above). For AXP, even had its multiple not contracted, its shares would still only have returned 1.6x, far inferior to MA's 2.9x. A graphic representation of the different contributors to the shares' returns is below:
MA Share Return Bridge (2013YE to Latest)
Source: MA company filings, Bloomberg Markets (29-March-19).
AXP Share Return Bridge (2013YE to Latest)
Source: AXP company filings, Bloomberg Markets (29-March-19).
Our view on MA's valuation is that its strong earnings growth would continue to more than offset the negative impact of any de-rating. Below are illustrative return calculations showing this - we have assumed compound annual growth rates ("CAGR") of 15% for both MA's EPS and dividend which, as will be explained later in this article, we believe are perfectly achievable.
The first table shows our downside case where, even if MA's P/E multiple were to contract from its 36.3x to 26.0x over the next 5 years, the annual return (Internal Rate of Return, "IRR") would still be 9% at the end of the 5-year period. (We have chosen a 26.0x P/E for the downside case because, as shown earlier, MA shares have finished each of last 5 years with a P/E above 26x.)
Illustrative MA Returns Calculation - Downside Case, P/E Falls to 26.0x
The second table shows our upside case where, should MA's P/E remain flat at 36.3x, then the annualised IRR would be 16% over the next 5 years - basically, the combination of EPS growing at 15% a year and a small dividend each year.
Illustrative MA Returns Calculation - Upside Case, P/E Flat at 36.3x
MA operates a global payment network for consumers and enterprises, with both credit and debit cards. For each transaction, MA's "four party" network typically connects the issuer, the merchant acquirer, the merchant, and the account holder. MA's network generates revenues by charging fees to issuers and acquirers for performing services, including:
These fees tend to be volume-based, calculated on the total value of transactions. Pricing is determined in a variety of ways, including regional price lists and individual deals.
MA also generates revenues from value-add products and services ("Other Service"), such as safety & security, card program management, etc.
MA is geographically diversified, with each continent represented solidly in its Gross Dollar Volume ("GDV"); however, it is currently not involved in China beyond issuing international cards with Chinese banks. North America is the most important, with 33% of MA's GDV and a slightly higher percentage of its revenues; Europe is 30% of GDV and APMEA 31%.
MA Revenue by Type (2018A)
Source: MA results release (18Q4)
MA Gross Dollar Volume by Region (2018A)
Source: MA results release (18Q4)
We have a high degree of confidence in MA achieving a "high teens" EPS CAGR for the medium term (or even the long term).
MA is a natural "GDP+" earnings grower, given how most MA revenues are based on the value of transactions, the rising use of electronic payments, and its ability to generate revenues without incurring much new costs.
MA has demonstrated a track record of strong growth in the number of cards, in total transaction value (Gross Dollar Volume, or "GDV") and in revenues.
As shown in the first chart below, since 2013, MA has had an average annual growth of 10% in the number of cards, 13% in GDV, and 15% in net revenues (all growth rates are in constant currency). This has enabled an average annual growth of 15% in MA's EBIT and 21% in EPS (the latter also helped by the U.S. tax cut in 2017), as shown in the second chart below:
MA Growth in # Cards, GDV & Net Revenues (2011-18A)
Source: MA company filings.
MA Growth in Net Revenues, EBIT & EPS (2011-18A)
Source: MA company filings.
(Note: GDV growth rates in 2016 and 2017 have been adjusted to exclude the impact from the EU Interchange Fee Regulation in 2015, which had a minimal impact on MA revenues. Net revenue growth in 2015 was impacted by a 20% increase in rebates and incentives, a contra-revenue item, which was due to the timing of new deals. Net revenue growth in 2018 was adjusted to exclude a 4% benefit from a new accounting standard.)
MA's GDV growth has been broad-based, with the U.S. still growing solidly and all regions seeing growth accelerate in 2018, as shown below:
MA Gross Dollar Volume Growth Year-on-Year (Local Currency) (2011-18A)
NB. Growth rates in 2016 and 2017 adjusted to exclude EU regulation change. Source: MA company filings.
MA's long-term growth potential is based on strong structural growth in both existing and newer markets, as shown in the chart below. MA's existing business is largely in the personal consumption expenditure ("PCE") market, but even there, the penetration of cards remains low. (Even in North America, cards are only c. 55% of PCE, and MA's GDV grew by 10% year on year in the U.S. in 2018.) Technological advances such as wireless connectivity and mobile devices have also opened up new markets in peer-to-peer ("P2P") and business-to-business ("B2B") payments, each larger than the PCE market, and where card use is minimal and many people still rely on cash and checks.
Global Potential Market Size (MA View)
Our confidence in MA's future revenue growth is also based on the competitiveness of its offerings vs. other card players.
We have already shown above how MA has grown much faster than AXP. MA is also competitive against Visa (V), with MA growing its volumes faster and thus gaining share vs. V globally, as shown in the first chart below. In the U.S., after losing some ground in early 2016 (but maintaining strong growth globally), MA has been holding its own and generating similar growth as V.
Gross Dollar Volume Growth - MA vs. V (Global)
Source: MA company filings, V company filings.
Gross Dollar Volume Growth - MA vs. V (U.S. Only)
Source: MA company filings, V company filings
(Note: All growth rates are year-on-year and in constant currency. V global growth rates before the Visa Europe acquisition in June-16 are excluded.)
In the U.S., since 2017, MA has maintained competitiveness vs. V, winning share among large issuers (see table below) as well as the more recent high-profile win in Apple Card. (The losses in 2016 were due to large contracts, with MA losing the United Services Automobile Association, and also allowing V to win the Costco U.S. contract from AXP.)
MA Update on US Market (Sept.-17)
Source: MA investor day presentation (Sept.-17).
MA management targets are for a "high teens" EPS CAGR (and a low-teens revenue CAGR) for the next forecast period of 2019-21, as shown below:
MA Medium-Term Objectives 2019-21
Source: MA results presentation (18Q4).
If growth were to slow, MA could protect its earnings growth by reducing costs, as MA has made large expense "investments" in recent years.
AXP has shown how the card business is scalable, requiring little incremental operating expenses ("OpEx"). As shown below, excluding marketing and card rewards/services (the latter do not apply to MA), AXP has reduced its OpEx at a CAGR of -3.5% in 2013-18. By contrast, MA has been growing its General & Admin. costs at a CAGR of 14.3% in 2013-18 - most of these as "investments" for future growth:
AXP OpEx (2011-18A)
Source: AXP company filings
MA OpEx (2011-18A)
Source: MA company filings
MA management has been explicit that recent growth in OpEx has been due to "investments" and can be reduced in a downturn:
On a currency neutral basis and excluding special items, total operating expenses increased 14%, which includes a 2% increase related to the new revenue recognition rules and acquisitions. The remaining 12% was primarily related to the company's continued investments and strategic initiatives
Martina Hund-Mejean, MA CFO (18Q4 earnings call)
If we see a sustained economic downturn then is where we'd like to take a look at some of the expenses … we've got a number of levers in our expenses, some of which have a shorter-term turnaround, some of which have a longer-term impact. And you should -- if you go back and look at our behavior around expenses some years ago, we're very committed to being managing our way through it.
Ajay Banga, MA CEO (18Q4 earnings call)
MA is currently trading on a P/E of 36.3x, a high level historically; since 2011, MA has finished each year with a P/E between 26x and 33x, as shown below:
MA Year-End P/E Multiples (2011 to Latest)
NB. Actual EPS figures used at each year-end. Source: MA company filings, Bloomberg Markets (29-March-19).
Since 2014, MA has returned nearly all of its net income to shareholders via buybacks and dividends:
MA Return of Capital vs. Net Income (2011-18A)
Source: MA company filings
(The difference between reported and adjusted net income is primarily litigation costs, which, while significant in some years, are not material to overall MA earnings.)
At present, there is net cash on MA's balance sheet, although borrowing for share buybacks will not be accretive, given there is little difference between MA's current cost of debt (2.7%) and the implied yield of its shares (2.8%).
MA generated $5.52bn of Free Cash Flow ("FCF") in 2018, implying an FCF yield of 2.3%. Excluding $1.31bn of working capital outflows, 2018 FCF was $6.84bn, implying a yield of 2.8%.
We believe MA's strong EPS growth more than offset its high valuation.
We believe MA will continue growing its EPS at a CAGR of more than 15%. It is a unique asset and a natural "GDP+" earnings grower, given its volume-based revenues, and the structural growth in both existing and new markets.
MA is currently on a P/E of 36.3x, admittedly high vs. its historic range (26-33x at each year-end since 2011). However, even if MA were to de-rate to 26x, a 15% EPS growth would still achieve a 9% IRR over the next 5 years. And, with its strong structural growth, MA shares could maintain their premium rating, in which case, the IRR would be in "high teens".
At $235.45, our recommendation on MA is Buy. We recommend building a position, but leaving room for further opportunistic purchases.
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Disclosure: I am/we are long MA. 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.