Mastercard: Volume Now 30% Above 2019, Strong Earnings Rebound To Come

Summary

• Mastercard's total volume was 30% above the 2019 level in the first 3 weeks of July, after being at 27% higher in Q2 and 21% higher in Q1.
• There was a spike in cryptocurrencies in from April to May; excluding this, the recovery in cross-border volume has been steady.
• Q2 revenues were 10% higher than in 2019, even with high-margin non-intra-Europe cross-border volume still at 79%; EPS was 3% higher.
• Shares are trading at 48.3x 2019 earnings, but we expect earnings to quickly rebound above that after COVID travel restrictions end.
• With shares at $385.94, we expect a total return of 50% (12.7% annualized) by end of 2024. Shares will likely exceed $650 in 2025. Buy.

Ekaterina79/iStock Editorial via Getty Images

Introduction

We review our Mastercard Incorporated (NYSE:MA) investment case after Q2 2021 results were released on Thursday (July 29).

We initiated our Buy rating on Mastercard stock in April 2019. Since then shares have gained 65% in just under 2.5 years, about 10 ppt ahead of the S&P 500, including 8.3% in 2021 year-to-date:

Librarian Capital's MA Rating History vs. Share Price Source: Seeking Alpha (01-Aug-21).

Click to enlarge

Mastercard has been one of the long-term winners in Payments, and we believe COVID-19 has accelerated its trajectory further. Q2 results provided another snapshot of its progress, and our updated forecasts show a total return of 50% (12.7% annualized) by 2024 year-end, in just under 3.5 years.

(Our other Buy ratings in Payments are Visa (V) and PayPal (PYPL).)

Mastercard Buy Case Recap

Our investment case on Mastercard has been based on our belief that its 15%+ EPS CAGR and premium valuation would continue, driven by:

• Electronic payment volumes are growing structurally, from both GDP growth and the continuing shift away from cash and cheques
• Even in the U.S. and Europe, a significant amount of consumer spending remains in cash; the potential is even greater in newer geographies
• Incumbent payment networks enjoy natural advantages in scale and network effects; regulations ensure a high barrier to entry
• Mastercard and Visa (V) are increasingly penetrating new payment verticals including Business-to-Business, Business-to-Consumer and Peer-to-Peer
• They are also increasingly providing value-add services that utilise their platform status and wealth of data, adding further revenue growth
• Payment networks have natural operational leverage, being highly scalable and having largely fixed costs, so earnings grow faster than revenues

COVID-19 has dramatically accelerated the shift to electronic payments, but international travel restrictions have diverted spending from high-margin cross-border volumes, materially reducing Mastercard's revenues.

We believe that new habits with electronic payments formed during the pandemic will persist into the future, while consumer international travel will return in strength as soon as restrictions are lifted, meaning that Mastercard's P&L will rebound strongly after COVID-19 to resume its 15%+ EPS CAGR.

Q2 2021 results provided more datapoints supporting our investment case.

Total Volume 30% Above Pre-COVID Level

In Q2 2021, Mastercard's Switched Volume rebounded 44% from Q2 2020, the first full quarter after COVID-19 lockdowns, and was 27% higher than pre-COVID 2019 figures, accelerating from being 21% higher in Q1; the figure was 30% in the first 3 weeks of July:

Mastercard Volume Local Growth (2021 vs. Prior Years) Key: XB = Cross-Broder, CNP = Card Not Present, CP = Card Present. Source: MA results presentation (Q2 2021).

Click to enlarge

Cross-Border Volume in Q2 2021 was 87% of the 2019 level, with Other Cross-Border (i.e. excluding Intra-Europe) Volume at 79% of the 2019 level, as most international travel remained heavily restricted. Intra-Europe Cross-Border Volume, which is lower margin, exceeded 2019 levels from June.

Within Cross-Border Volume, Travel has continued to recover, from being at 38% of 2019 level in Q1, to 57% in June and 66% in July month-to-date.

Cross-Border Spike Due to Cryptocurrencies

Cross Border Card Not Present excluding Travel ("XB CNP ex. Travel" in the table above) first accelerated to 174% of 2019 level in May, then moderated to 159% in June and 148% in July. Mastercard stated this was "in part" due to lower cryptocurrency purchases and e-commerce promotions in 2019.

Visa's Cross-Border Volume (excluding Intra-Europe) data showed the same pattern, with "Card Not Present, Excluding Travel" decelerating from being at approx. 160% of the 2019 level in May to approx. 140% in July:

Visa Cross-Border Volume, Indexed to 2019 (Ex. Currency) (Since April 2021) Source: Visa results presentation (Q3 FY21).

Click to enlarge

Visa attributed the deceleration to cryptocurrencies, and described the higher May level as a "spike" mostly attributable to cryptocurrencies:

(We observed) a spike in cross-border cryptocurrency purchases from mid-April through the end of May ... Cross-border card-not-present volume, excluding travel, continued to be very strong, up 56% from 2019, improving 12 points from the second quarter, with cryptocurrency purchases representing most of that acceleration. We have seen more active cards and more spend per card in cryptocurrency purchases.

Vasant Prabhu, Visa CFO (Q3 FY21 earnings call)

Excluding cryptocurrencies, the recovery in Cross-Border Volume has been steady, though the next stage of significant improvement will likely only occur after international travel restrictions are no longer widespread.

Sequential Momentum Continued into Q2

Mastercard's Q2 2021 Purchase Volume was 13% higher than Q1 globally, including 15% higher in the United States. The number of cards (excluding Maestro) was 2.6% higher than Q1 globally, including 4.3% higher in the U.S.:

Mastercard Operational Performance (Q2 2021 vs. Prior Periods) Source: MA results supplement (Q2 2021).

Click to enlarge

These figures show strong momentum in Mastercard's business, even if we exclude some of the growth as due to the spike in cryptocurrency purchases.

Group Earnings Now Above 2019 Level

Mastercard's Q2 2021 P&L showed a 31% rebound in revenues and a 36% rebound in its Net Income from the prior year (excluding currency). Compared to Q2 2019, revenues were 10% higher, EBIT and Net Income were flat-ish (up 0.4% and down 0.1% respectively); EPS was up 3% due to buybacks:

Mastercard P&L (Q2 2021 vs. Prior Periods) Source: MA results release (Q2 2021).

Click to enlarge

Other Revenues, which include Mastercard's value-add services, rose 32% year-on-year. Excluding 9 ppt from acquisitions, organic growth still exceeded 20%, mostly driven by Cyber & Intelligence and Data & Services solutions.

EBIT and Net Income were flat-ish from 2019 despite higher revenues because Operating Expenses ("OpEx") have risen 23.6%. Mastercard has resumed investments in anticipation of a recovery - Q2 OpEx was 8.3% higher than Q1, with the bulk of the increase ($97m out of $162m) in Advertising & Marketing. Acquisitions also added 8 ppt to year-on-year OpEx growth.

Mastercard was able to cut costs when the future was still uncertain during the early parts of the pandemic. OpEx shrank by 5 ppt year-on-year in both Q2 and Q3 of 2020 (or, excluding acquisitions, by 9 ppt and 8 ppt respectively):

Mastercard Operating Expenses by Quarter (Since 2019) Source: MA company filings.

Click to enlarge

Currency was a tailwind in Q2, adding about 5 ppt to revenue and Net Income.

Q3 Outlook Implies Steady Recovery

For Q3 2021, Mastercard expects Net Revenue growth to be in the "high-end of mid 20s" organically, or "high-end of high 20s" including acquisitions and currency. OpEx growth is expected to be in the "high-end of mid-teens" organically, or high 20s including acquisitions and currency:

Mastercard Q3 2021 OutlookSource: MA results presentation (Q2 2021).

Click to enlarge

The outlook implies Q3 2021 revenues will be approx. 10% higher than Q3 2019, similar to what we saw in Q2 2021, while EBIT would be 3% higher:

Mastercard Q3 EBIT vs. Prior Periods (Implied) Source: Librarian Capital estimates.

Click to enlarge

Management's outlook assumes "spending levels to continue to improve along the current trajectory", and the P&L implies a steady recovery.

Valuation - Is Mastercard Stock Overvalued?

At $385.94, relative to 2020 financials, Mastercard shares are trading at a 59.4x P/E and a 1.6% Free Cash Flow ("FCF") Yield; relative to pre-COVID 2019 financials, the P/E is 48.3x and the FCF Yield is 1.9%:

MA Net Income, Cashflows & Valuation (2016-20) Source: MA company filings.

Click to enlarge

We believe even the lower, 48.3x P/E figure overstates Mastercard's valuation. Volume is already approx. 30% above its 2019 level, Net Income is only about the same at present because volume has been temporarily diverted from high-margin cross-border spending by international travel restrictions. We expect a quick rebound in earnings when these are lifted.

Mastercard's Dividend Yield is 0.5% ($1.76 per share), after the quarterly dividend was raised by 10% in December 2020.

Mastercard has repurchased $3.47bn of its shares year-to-date (as of July 26), equivalent to 0.9% of its market capitalization.

Mastercard Stock Forecasts

Compared to our most recent forecasts in May, actual Q2 Net Income was approx. 23% higher, but the Q3 outlook was approx. 6% lower. We reduce our Q3 forecast correspondingly but keep Q4 changed, which is for a Net Income that is 10% higher than in 2019:

Mastercard Net Income by Quarter - Historical & Estimates Source: Librarian Capital estimates.

Click to enlarge

Our new 2021 forecasted Net Income is 2.3% above 2019 (was 0.2% lower).

We keep our other assumptions unchanged:

• 2021 Net Income to be $8.25bn (was $8.04bn) as explained above
• 2022 Net Income to grow 20% year-on-year (unchanged)
• From 2023, Net Income to grow by 15% each year (unchanged)
• 2021 share count to be 994m (was 996m)
• From 2022, share count to fall by 1% each year (unchanged)
• 2021 dividend to be $1.80 (unchanged)
• From 2022, dividends to be based on a 25% payout ratio (unchanged)
• 2024 P/E of 42x (unchanged), implying a 0.6% Dividend Yield

Our new 2024 EPS estimate of $13.57 is 3% higher than before ($13.20):

Illustrative Mastercard Return Forecasts Source: Librarian Capital estimates.

Click to enlarge

With shares at $385.94, we expect an exit price of $570 and a total return of 50% (12.7% annualized) by 2024 year-end, in just under 3.5 years.

If Mastercard continues its mid-teens EPS CAGR and retain a 42.0x P/E multiple, it share price will exceed $650 by 2025 year-end.

Is Mastercard Stock a Buy? Conclusion

Mastercard's total volume was 30% above the 2019 level in the first 3 weeks of July, after being at 27% higher in Q2 and 21% higher in Q1.

There was a spike in cryptocurrencies in from April to May; excluding this, the recovery in cross-border volume has been steady.

Q2 revenues were 10% higher than in 2019, even with high-margin non-intra-Europe cross-border volume still at 79%; EPS was 3% higher.

Shares are trading at 48.3x 2019 earnings, but we expect earnings to quickly rebound above that after COVID travel restrictions end.

With shares at $385.94, we expect a total return of 50% (12.7% annualized) by end of 2024. Shares will likely exceed $650 in 2025. Buy.

Note: A track record of my past recommendations can be found here.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of MA,V, PYPL either through stock ownership, options, or other derivatives. 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.

Comments

[Librarian Capital]

Mastercard CFO Sachin Mehra, in his appearance at the Deutsche Bank Technology Conference today (10-Sep), provided several key updates:

1/ Mastercard’s cross-border volume (including intra-Europe) has returned to 2019 level in August

2/ The latest Aiia acquisition will give Mastercard connectivity in Europe the same way its Finicity acquisition did in the US

3/ BNPL works better with open-loop networks like Mastercard and Visa

4/ Mastercard treats cryptocurrencies as asset class - it doesn't handle crypto or its conversion into fiat

5/ Regarding the Fed’s proposal on debit card routing exclusivity provisions, Mastercard will comply with changes. Its debit card offering is competitive, as many networks have "gaps" in their safety and security features, due to an historic underinvestment in card-not-present security (having relied on PIN in card-present transactions)

[High_Table]

@Librarian Capital The confusion here around BNPL is just so interesting.

1. BNPL is providing credit to buyers who aren't using credit cards- its providing credit to the marginal debit/cash buyer (who is a higher credit risk). Industry 'disruptors' are too excited about lending money to people in the short term and are not thinking about the credit cycle. I think back to my experiences being asked to do the work on SoFi and Prosper and CommonBond, LendingClub- big "disruptors" back in 2013-2016. These have been failures in the context of disrupting the traditional banking & lending system.

2. BNPL may be awesome for getting financing on that TV from BestBuy or a Peloton- but how is a separate BNPL app useful for day to day purchases at CVS/subway NFC/debit or credit NFC at restaurants and so many other merchants? You want to disinter mediate V/MA, you'd better make usage and acceptance global like they do. Otherwise, you're a niche solution. Which might be nice for you but doesn't put my V/MA investment at risk. Even so, BNPL is being implemented by V/MA anyway. No one has a monopoly on issuing/selling/lending a financial product- finance is commoditized-and BNPL is a purely financial product.

3. Consumers are using debit cards to pay off BNPL. So the BNPL players would have to divorce consumers from debit networks and push them to ACH to truly disinter mediate the card networks.

4. ...And: ACH is a very slow technology. Bank to bank clearing that requires manual work on part of the bank to clear. Maybe it becomes faster/automated in time, but thats not a solution that has a clear path to being 10x faster/simpler/convenient than existing cards.

I followed you on twitter btw.

[Librarian Capital]

@High_Table

Good points, especially #2 and #3 (which I also touched on in Twitter).

There have always been sporadic attempts to disintermediate credit card networks - the latest one is in European airlines, led by Emirates. But sooner or later they all run into the limitations of a closed loop.

Merchants cannot force consumers to use a particular payment method unless they disallow everything else, but disallowing most payment methods would mean losing too much business to competitors.

I think the only attempt close to success at scale is Costco, which in the US only allows 1 credit card network (AXP before 2016, Visa after). Otherwise nearly all attempts have earned in failure.

[European1955]

Thanks again for your excellent analysis.

In your initial note you quote much lower P/E ratios

'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:'

I'd be interested to hear your views on more recent changes in P/E ratios and justification for using higher ratios.

I think this is getting very close to buy territory.

[Librarian Capital]

@European1955 Thanks. No question that P/E multiples have gone higher across the market.

To be clear, what is important is the long-term P/E, not the current P/E. What matters is whether, when we combine the long-term P/E and our EPS estimate, does buying a stock now make sense. As an extreme example, people can make a profit on buying loss-making businesses (which have an infinite P/E).

In Mastercard's case, I have assumed a 42x P/E (for Visa I have 40x).

Again this is higher than its historic range. However, historic data, whether it's earnings or valuation multiples, is only one of the datapoints that need to be taken into account when predicting long-term valuation.

Valuation multiples, being the inverse of yields, represent what investors can get in return when holding a stock, and is impacted by what else is available and the relative risk between the two. This is the concept of the "equity risk premium" - my yield from equities should be higher than the risk-free rate, with the gap determined by the extra risk involved and the risk-free rate usually taken as the long-term US Treasury yield. (10-year is at 1.33% and 30-year is currently at 1.94%).

My view is that US Treasury rates will stay low. Perhaps not as low as now but no more than a 2-3% percent. Reasons include both government and private indebtedness, politics and demographics.

On the other side, stocks like Mastercard have earnings that have proved relatively resilient through multiple crises (almost as good as Treasuries) and are structurally inflation-proof (much better than Treasures). I therefore do not expect the equity risk premium to be that high.

All in all, I am comfortable with a 42x P/E for MA, which is a 2.4% yield.

Is this a change from the assumptions I had a few years ago? Yes. But frankly I made a mistake in being too cautious about this and would have made even better returns had I understood things sooner.

Anecdotally, Fundsmith used to tell investors they require a minimum 4% FCF Yield in their holdings. If you look at their portfolio now, this is obviously a criteria they no longer maintain.

[European1955]

@Librarian Capital Thank you for your detailed and considered response. I tend to agree.

However the operating performance suggests that the higher ratios are more than justified.

2011/2019 figures (%, source: Morninstar) are
RoA 19.52 48.01
RoE 34.43 134.83
RoIC 34.09 64.76

Operating Margin 40.41 57.43
Net Margin 28.39 48.08

These are huge improvements and in my opinion justify higher valuations. I think the MA business model suggests that these figures can continue to improve

Your point about Fundsmith is well made. Their average FCF yield now must be under 2.5%, even assuming very good FCF growth (13%), this year.

[Librarian Capital]

@European1955 Thank you.

I agree that operating performance at both Mastercard and Visa have improve further; their businesses have increasingly broadened beyond Personal Consumption Expenditures into value-add services and B2B.

I suspect valuation multiples are driven more by future growth prospects than current margins or return on capital, however. For example, Visa has a higher EBIT margin than Mastercard (66.6% vs 53.2% in Q2 CY21), but has traded at lower multiples fairly consistently.

[Librarian Capital]

FYI, Visa US volume at 130% of 2019 in Aug, vs. 133% in Jul. Food, drug & fuel better; other categories worse w/ Travel down 7 ppt. Non-US volume "increased" in Aug vs. Jul (as % of 2019). Cross-border volume improved in Aug, at 85% of '19 level vs. 81% in Jul (ex. intra-Europe).

[EverydayJoeSchmo]

AAL, DEL, CCL all up today, and MA and V are tanking 3 percent. What the hell is happening?

[Librarian Capital]

@EverydayJoeSchmo To be honest I have no idea. It's especially mystifying because other and more expensive stocks, including in Payments like PayPal, did much better.

[Doggywag]

@Librarian Capital I think the sagging in some payment stocks has to do with an increase in "delta fear" and its impact on travel. The fear level waxes and wanes. I watch the numbers closely and although the media keeps referring to the "delta surge," the numbers in the US and globally have peaked and appear to be heading down. So this could be a very good time to buy stocks like MA and V.

[Librarian Capital]

@Doggywag Yes, my theory is centered around growing fears about Mastercard's and Visa's cross-border volumes too.

[Doggywag]

The stock continues to get creamed. After watching it for ages, I finally bought today around $342. At some point you have to just dive in.

[Librarian Capital]

@Doggywag Thank you for sharing and good luck.

[Sergi Medina]

Added today.
Long MA.

[Librarian Capital]

@Sergi Medina Thank you for sharing. Same here - fingers crossed.

[Rowbearto]

We got into MA on the IPO back in 2006 and I would love to see $650 by 2025. I remember many "analysts" were dissing the IPO. I wish all my buys were this profitable. cost basis of $3.90. I'd be happy with $450 by 2025.

[Librarian Capital]

@Rowbearto Congratulations on your 100-bagger!

[Librarian Capital]

Mastercard share price fell 10% in Aug, now down YTD.

$MA trades at 43x 2019 EPS. Compared to 2019, volume was 30% higher in Jul 1-21, revenues were 10% higher & EBIT was flat in Q2, while share count was 3% lower after buybacks.

[Humble_Modesty]

@Librarian Capital

Just scrolled through to see what’s affecting MA. Don’t see much news, valuation based on growth isn’t crazy. Maybe they need to adopt some form of blockchain to make themselves more relevant going forward.

[Librarian Capital]

@Humble_Modesty

A delay in international air travel due to new COVID variants is probably the main cause of share price weakness. International travel is the last part of the economy to recover, after restaurants and domestic travel.

Mastercard also had a higher starting P/E.

I don't think blockchains are relevant to MA in the way you suggested.

[Humble_Modesty]

@Librarian Capital

From what I understand MA is widely held by hedge funds. I wonder if there’s some kind of dump or rotation taking place.

[ozcutty1]

Wow only up 3% in last 12 months. People are so short sighted, will be making big money when travel returns and we get some inflation

[Librarian Capital]

@ozcutty1

Yes, Mastercard shares are now trading at 45x pre-COVID 2019 EPS, which by itself is lower than the P/E of many software companies that are not growing EPS at double-digits. Relative to 2022 consensus estimates, it is on a 34x P/E, which is cheap on my opinion.

[Librarian Capital]

"Mastercard faces biggest UK class action lawsuit" (the FT)

No trial date set yet; "decision had been expected"; ruling also excludes compound interest & estates of consumers who died in '92-'08, cutting claim from £14bn to £10bn. $MA "confident" of further cuts in claim size & viability.

[Doggywag]

@Librarian Capital These court cases rarely seem to do much to stocks.

[Librarian Capital]

@Doggywag Indeed. I posted my comment in case people were curious, that was all.

[Acewarp]

@Librarian Capital - thanks for the detailed and helpful analysis. Belatedly, I am writing to ask if you have any thoughts on the impact to Mastercard, Visa and the banks of the clearly emerging BNPL product which has received so much news attention these past few days (especially with Square's $29 bn acquisition).
I've noticed that the card networks' stock prices have declined meaningfully the past few days, more so than the market generally. Do you have any analysis of the market segments for BNPL, versus credit card loan market? Clearly the products (BNPL vs card borrowers) are different tenor borrowings and may reflect different borrower creditworthy classes and needs. But any data or insights you have on this would be appreciated. Many thanks.

[Librarian Capital]

@Acewarp I don't have the kind of data you are looking for - my apologies.

I would attribute the recent share price decline to expectations of Fed tapering, but that is a subjective opinion.

Mastercard and Visa have a role to play in BNPL, as networks helping banks who want to provide this.

Ultimately banks are desperate for interest income and credit cards represent one of the most attractive sources of this in their view, so they will want to be involved. Chase, for example, has its My Chase Plan.

[Acewarp]

@Librarian Capital Ok, thanks for the quick response and your take on this. My sense (admittedly from 1,000 foot view), is that Chase and BAC will be able to sort the borrower groups out, address with tailored products, and not suffer too meaningfully. Regional and smaller banks may not be able to do that effectively, given their customer bases. And if they lose card business to BNPL users who move to Square and Paypal, that will also hurt the card networks. Will be looking closely for clues/trends on this in coming quarters. Thanks.

[kata]

How are gross profit margins 100%?

[Librarian Capital]

@kata I assume that figure comes from some third-party database.

Mastercard's reports do not mention Gross Profit. Costs of Good Sold for what they do is not clearly defined, since it's all virtual (services).

[kata]

@Librarian Capital

thanks, from SA

[Librarian Capital]

@kata Examples like this make me feel better about having input all data by hand personally on all the companies I cover.

[BM Cashflow Detective]

I like almost everything about MasterCard. Technology upgrades, product diversifications and so much more.

I'm long $MA. My largest portfolio position.

According to your estimates, I determine in each case:

TTM PEG ratio of 1.76.

2y PEG ratio of 2.03 and

3y PEG ratio of 2.32.

A PEG ratio in the range of 2 clearly supports a buy rating.

The company is clearly set for long-term growth. Wonderful.

[Librarian Capital]

@BM Cashflow Detective Congratulations on what must be good gains on your MA holding to make it your largest position.

Personally I am not a fan of PEG ratios.

[BM Cashflow Detective]

@Librarian Capital

Many Thanks.

From my point of view, very pity. But I like this metric because it ensures a significantly better valuation comparability than just the P / E ratio alone.

May I ask why?

[Librarian Capital]

@BM Cashflow Detective The P/E part is too short term and the implied relationship too linear.

[Leandro_Santos]

Why the assumed 42 PE multiple in 2024? I think that's excessive
Good article nonetheless

[Librarian Capital]

@Leandro_Santos Thanks. 42x P/E is the equivalent of a 2.4% yield, reasonable for what is basically a bond with a coupon that grows faster than inflation and is mostly as resilient.

This compares well with 30-year US treasury bond yields, currently yielding 1.9% and has been yielding less than 3% for most of the time since 2014, with a fixed coupon.

It also compares with inflation-proof bonds like TIPS offer a negative yield. (-1.6% for 5-year).

[ADrunkenMarcus]

I’m a happy holder for the long run!

I’m interested in what’s your basis for assuming a 25% dividend payout ratio from 2022? I’d enjoy that.

[Librarian Capital]

@ADrunkenMarcus Thanks, and congrats on your gains.

With the payout ratio, as an assumption on how the Net Income is spent, I generally assume more dividends because this is more conservative (in terms of EPS accretion) than more buybacks. The Payout Ratio was 25% in 2020 and has averaged just under 20% in 2016-20. MA share price carries a higher P/E than before, and I would expect this to make buybacks correspondingly less attractive compared than dividends.

In any case, with the Dividend Yield at 0.5%, this is not a material assumption.

[ADrunkenMarcus]

@Librarian Capital Thanks for the explanation. It makes sense.