- Mastercard's business will be affected by COVID-19 as well as the upcoming recession as spending will decrease.
- But Mastercard can profit from a potential shift in payment behavior over the long run.
- With an intrinsic value of $211 Mastercard remains overvalued at this point.
This week, I will continue my series with the financial services company Mastercard (NYSE:MA). You should not be surprised, that this article is very similar to the article about Visa (V), which was published last week, as the business model of both companies is very similar. It is therefore quite logical, that Mastercard is affected in a very similar way as Visa. Last week, when I published the analysis about Visa, I had to rely on preliminary data and 8-Ks, while for the Mastercard article the analysis can rest on the earnings release from last week.
All these articles will follow the same structure and focus on four different aspects that seem to be very important right now:
- Impacts from COVID-19: I am trying to analyze how COVID-19 as well as the measure and political decisions (lockdowns, social distancing, closures, etc.) will affect the business model.
- Impacts from a potential recession: As a global recession seems to be inevitable, I will also analyze how a recession will impact the business model.
- Solvency and Liquidity: In turbulent times, debt levels, solvency and liquidity are especially important and we are therefore taking a closer look at the balance sheet.
- Intrinsic Value Calculation: Although I included a potential recession in the near future in almost all calculations and considered a declining free cash flow, COVID-19 might call for an update of the intrinsic value.
(Source: Author's own work)
Impacts From COVID-19
Similar to Visa, Mastercard is also generating most of its revenue by processing payments and from authorization, clearing and settlement of payment transactions. And as credit cards are often used when traveling abroad, Mastercard was affected already in January when Hubei went on lockdown and countries as well as companies started to suspend traveling. As a result, cross-border volume fees declined pretty early. In late February, Mastercard still expected net revenue growth of 9-10%, but with the full effects of the pandemic and the resulting lockdowns and shelter-in-place, Mastercard released an 8-K on March 24, 2020 and not only withdrew its guidance for the year, but also gave the following estimates for the first quarter:
First quarter growth in net revenue in the low-single-digits range. We have also seen some shifts in foreign exchange rates and anticipate that the currency impact will be about a 2-percentage point headwind to net revenue growth in the first quarter.
Last week, Mastercard reported a revenue of $4,009 million for the first quarter of 2020, which is still reflecting revenue growth of 3% and adjusted diluted earnings per share also increased about 3% from $1.78 a year ago to $1.83 this quarter. GAAP earnings per share decreased from $1.80 in the same quarter last year to $1.68, reflecting a decrease of 7%. The gross dollar volume was up 8% in local currency basis while the cross-border volume was down 1% in local currency basis. The number of cards still grew 5% compared to the same quarter last year and switched transactions increased 13% to 22.1 billion transactions. When looking at the different segments, only cross-border volume feeds decreased 4% compared to the same quarter last year.
(Source: Mastercard Investor Presentation)
When looking at the cross-border volume trends, we see that until the beginning of March, the effects of COVID-19 did not really kick in and Mastercard could still report growth. But during March the decline really set in and cross-border volume with card present declined more than 80% at the end of March and is stagnating at that level during April.
The following chart is illustrating why the first quarter is not really representative - not for Mastercard, not for Visa and also not for most other companies. While in the first two weeks, the switched volume was still growing 8%, we see declines between 20% and 30% in the weeks of April.
(Source: Mastercard Investor Presentation)
And although it seems as if the last week of April is showing first signs of improvement again, we have to see how quickly the business will recover. The second quarter will definitely be much worse than the first quarter and in countries where economies are trying to open up again, the buying behavior is not the same as before (we can look at Austria for example). It is difficult to say if and when customers will spend money in the same way as before and at least international travel will probably take several quarters to recover and revenue from cross-border volume fees will probably also stay at a depressed level for several quarters. In the earnings call, management promised, that they will provide periodic updates on the operating metrics throughout the quarter and we will have to watch the next few weeks and months very closely.
Impacts From A Recession
And similar to Visa's business, Mastercard will also be affected by the upcoming recession and with more than 30 million people having claimed for unemployment insurance in the last six weeks, the spending behavior of people might change. And although many millions of workers might only be furloughed and might have their jobs again in a few weeks or months from now, it seems extremely unlikely that we will see similar unemployment numbers in the next few years as before the pandemic and the resulting crisis. Millions of people without a job (not only in the United States, but in many other countries all over the world) will decrease spending and therefore have a negative effect on Mastercard's revenue in the coming quarters.
We can also look at Mastercard's performance during past recessions to get a feeling of how the company might perform in the coming quarters. In case of Mastercard we can only look at one recession - the Financial Crisis - as Mastercard went public in 2006 and we don't have numbers from the years before. When looking at the years during the last recession, we can see that Mastercard was able to increase its revenue every single year. In 2009, revenue grew only 2.1% YoY, but in all the other years we saw growth in the high single digits or even double digits. Net income actually declined in 2008 (it was even negative), but in all the other years, net income could increase and in 2009 net income was higher once again than in 2007. The reason for the negative numbers in 2008 was a $2.5 billion litigation settlement and when not including these expenses, Mastercard would also have increased its net income in 2008 as in all the other years.
Like with all the other companies before, we also have to look at the company's financial health as in times of declining revenue and liquidity drying up, the company's balance sheet becomes especially important. On March 31, 2020, Mastercard had $10,207 million in cash and cash equivalents and $477 million in short-term investments. Even if revenue and operating income should decline, we should not worry about the liquidity of Mastercard.
Aside from liquidity, we also have to look at the long-term and short-term debt of Mastercard as solvency is another important aspect. On March 31, 2020, Mastercard had $12,466 million in long-term debt. When comparing the amount to Mastercard's equity of $5,423 million, we get a D/E ratio of 2.30, which is quite high. Nevertheless, we should not worry about the financial health of Mastercard as the company has enough cash on it balance sheet to repay a huge part of its debt. And when considering the annual operating income ($9.7 billion in 2019), it would take less than one and a half years to repay the outstanding debt and therefore we must not worry about the debt levels.
(Source: Mastercard 10-K)
When we are looking at the debt levels that are due in the next few years, we should also not worry as Mastercard has to repay only $650 million in 2021 and $785 million in 2022 (no debt has to be repaid in 2020 and 2023). And finally, Mastercard has also announced, that it has temporarily suspended its 2020 share repurchase activity with $6.9 billion remaining under current repurchase program authorization.
Intrinsic Value Calculation
Finally, we are calculating an intrinsic value for Mastercard and our assumptions for future cash flows will be quite similar as for Visa. It sometimes seems as if Mastercard gets ascribed a higher multiple than Visa and growth expectations for Mastercard seem to be a little higher. But when looking at the past, both companies perform quite similar and it makes sense to use similar assumptions for Mastercard as for Visa. In my opinion, both companies don't have to battle each other for market share as the underlying market is still growing with a high pace and offers enough growth opportunities for both companies.
When looking at the long-term performance of Mastercard since 2002 (the oldest data I could find), Mastercard could increase its revenue 13.97% on average and net income could be increased 27.78% on average during that timeframe. Free cash flow could be increased 23.03% annually on average since 2004 (I couldn't find numbers from 2002). When looking at management's own long-term revenue growth potential (before COVID-19), they see the number at least in the low double-digits.
Due to the above-mentioned negative impacts from COVID-19 and the upcoming recession, I will assume a 10% decline in 2020 and free cash flow to stay at that lower level in 2021. From 2022 going forward, I will assume 11% growth till the end of the first decade and following that, 6% growth till perpetuity (the same assumptions I used in my Visa article). Using these numbers (and - as always - a 10% discount rate) leads to an intrinsic value of $211.20 for Mastercard. And - like in all other articles in this series - I will include a 20% margin of safety to reflect the high levels of uncertainty. This leads to an entry point of $168.96.
Similar to Visa, Mastercard has a very stable business model and while it will be affected by COVID-19 and the shelter-in-place orders as well as the upcoming recession, we don't have to worry about Mastercard in the long run. In the meantime, Mastercard might be affected in the next two years by the decreased spending of people due to closed stores and high unemployment. When looking just at the D/E ratio, Mastercard's debt seems to be extremely high, but we also have to consider the cash and cash equivalents and the high amounts of operating income, when assessing the company's financial health and we shouldn't worry neither about liquidity nor solvency. Nevertheless, Mastercard is still overvalued right now and far away from the preferred entry point.
In my article about Visa, I mentioned long-lasting shifts in the payment behavior of people, which might benefit Visa and these long-lasting shifts in payment behavior might also benefit Mastercard. This crisis could lead to more and more customers switching from hard cash to some other form of contactless payment leading to even higher growth rates in the years to come.
(Source: Author's own work)
Stay safe, stay healthy, don't panic!
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