Mastercard: Short-Term Pain, Long-Term Gain

Oct. 18, 2020 11:36 PM ETMastercard Incorporated (MA)13 Comments13 Likes

Summary

  • COVID has created a situation which has impacted Mastercard's business in the near term, likely for the next few quarters.
  • Q3 earnings will be reported in a few weeks and there are several key metrics to watch.
  • Based on what we are seeing to date, we see 2020 revenues coming in at $15.0-16.0 billion and earnings per share coming in at $6.00-7.00.
  • Expect ongoing normalization as the economy reopens.
  • Looking for a helping hand in the market? Members of BAD BEAT Investing get exclusive ideas and guidance to navigate any climate. Get started today »

Prepared by Tara, Senior Analyst at BAD BEAT Investing

Mastercard (NYSE:MA) will report its third-quarter earnings in a few weeks and we want to be very clear that we think shares are a great long-term buy on any significant pullback. Make no mistake, COVID has created a situation which has impacted Mastercard's business in the near term, likely for the next few quarters. Still, despite the obvious declines, it continues to deliver solid performance in 'the new normal' as it were. As the crisis continues there will be reduced volumes, less consumer spending, and a slowdown in growth, likely for the next quarter or so. However, we think that despite the rebound in shares, there is opportunity here. Overall, we saw a progressive improvement in volume trends over the course of the second quarter, driven by the opening up of domestic economies. That continued into Q3. And today, we believe that most markets are in the normalization phase domestically and spending has begun to gradually recover with some sectors recovering faster than others.

Valuation-wise, the stock has long been overvalued, but that valuation has come in lower, particularly if we 'exclude' the earnings impacts over the next few quarters and look to 2021. On the next pullback, we think this stock still makes an excellent addition to any portfolio focused on growth. With the huge economic impacts of COVID-19 it is still overvalued in the traditional sense. For years, the argument of the name being overvalued has been made, but shares continued to rise. With Q3 earnings coming in a few weeks, we wanted to check back in and discuss the trends we will be looking at by examining what we saw in Q2.

Volume declines hit revenue, expect declines in Q3

Despite the economy reeling the overall data remains relatively strong, particularly against expectations. The reported second-quarter saw top-line contraction though as there were clear pressures. Growth has slowed given COVID-19-related shutdowns and reduced spending power of a chunk of consumers.

The past growth in revenues had been impressive. Here in Q2 2020, economic activity slowed heavily. Internationally, activity began slowing even earlier. We expect Q3 and Q4 will see pain as well, but think Q4 2020 and 2021 are set to see a ramp-up in activity. Things have gotten substantially better since Q1. It is not the virus itself that killed growth of course, but the actions of the government to try and stop the spread. People are being cautious and not going out as much. At the same time e-commerce has really exploded. Mastercard benefits from the latter of course. We think as things reopen it gets better. Net revenue for the quarter came in at $3.3 billion, a 19.5% decrease from Q2 2019. This was primarily due to a steep drop in gross dollar volume and in processed transactions. Expect a decline in Q3 as well.

Mastercard saw a 10% drop in gross dollar volume, at the higher end of our wide range for COVID-19 impacted Q2 expectations for 8-14% declines, and saw a 10% decrease in transactions processed, also better than the declines of 7-13% we thought we might see. The transaction declines drove the declines we saw in revenues. As we mentioned earlier, internationally, things slowed down before they did in the U.S. As such, cross-border volumes took a huge hit once again. They contracted 45%. Expect more declines in Q3, but not so steep. We expect to see double-digit declines in cross-border volumes in Q3, as well as mid-single-digit declines in processed transactions.

Operational expenses fell, should be down in Q3 as well

With revenues falling in Q2 we expected expenses to decline. We think that happens in Q3 as well. Expenses fell year over year vs. last year by 9% on an adjusted basis. On a currency-neutral basis, expenses were down 5%. Total adjusted operating expenses were $1.6 billion for several reasons, including primarily spending related to strategic initiatives, as well as lower promotional spending and of course acquisition-related integration expenses. When we factor in the decrease in revenues, we see that it led to operating income decreasing as reported at $1.7 billion. We expect declines in operating income in Q3, though less so than what we saw in Q2. With the top-line contraction and margin contraction, we saw a big drop in adjusted EPS. We expect a decline in Q3 EPS as well.

Earnings stumble but better than anticipated. Expect some improvement in Q3

With the decline in revenues, earnings fell, and we expected a decline down to as low as $1.20. We saw fewer transactions being processed, we had lower revenues, and narrowing margins. Again, expect Q3 to also be painful, but the market has essentially given these COVID-19 quarters a pass. Much like the revenue trend, the EPS trend stalled in Q2. Net income was down to $1.4 billion versus the $1.9 billion a year ago, and hit $1.36 per share versus $1.89 per share. As we move forward, we expect EPS growth to remain stalled in the next quarter, and possibly into Q4. For Q3, we are expecting $1.70 in earnings, considering a decline in revenues to $4.0 billion. This would be down from last year.

Q3 while declining, may show signs of some stabilization, and this drives our 2020 projections

The shape and speed of the recovery will be determined by the effectiveness of policy initiatives. It is tough to forecast though, and handicapping performance is really tough right now. Sectors like home improvement, clothing, and out-to-eat dining have been normalizing. We are hopeful that domestic and intra-regional travel will normalize as the year progresses, while entertainment and international travel will probably take longer to recover.

Based on what we are seeing to date, we see 2020 revenues coming in at $15.0-16.0 billion and earnings per share coming in at $6.00-7.00. This is based on annual volumes increasing in the low single-digits, contraction in cross-border volumes in the single-digits, and operational expenses higher in the low single-digits overall.

Final thoughts

If the stock falls back, we think you should buy it. Under $300 was what we would have loved to have seen, but that is going to take a big selloff. Perhaps if shares retrace 5%, you can start buying again. If the general market takes a hit, we may get an opportunity. If Q3 misses our estimates, the stock may fall. That said, it is a great long-term buy.

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