Mastercard Inc. (MA) has had a bumpy ride so far in 2010. After posting a new recovery high near $270 in early January, the stock lost roughly 20% of its value after the company issued a disappointing fourth quarter report. While the card issuer’s revenue was up 6% and earnings actually increased by 31%, investors were less than pleased. Nearly all of the growth in earnings came as a result of cost cutting within the firm and even the 6% increase in revenue was primarily a function of currency fluctuations and not a real growth in business.
Back in 2008, MA became extremely weak as traders (myself included) expected the consumer to rein in spending and transaction volume to decrease. Not only were we working against a general panic among both professionals and individuals, but spending was also to be affected by tighter credit limits, decreased card issuance, and higher fees charged by banking institutions. Many consumers had to scramble and find alternate sources of funding such as a direct payday lender or other non-traditional measures.
But as investors regained confidence in 2009, the stock made back a good portion of its losses as Mastercard reported a continually growing chain of quarterly earnings. The last four quarters featured EPS growth of 9%, 27%, 41% and finally 31% in the fourth quarter. But a lack of revenue growth points to the fact that Mastercard manufactured the majority of its earnings growth through controlling expenses and not as a result of a material increase in the business. In fact, the last four quarters of revenue growth have been (2%), 3%, 2%, and 6%. Not exactly what you would expect out of a stock priced for growth.
It would appear that the future of Mastercard’s success (and the returns its investors will receive) hinges as always on consumer spending levels. Since MA provides only the credit card transaction portion of the business, it is not on the hook for losses when consumers become unable to make payments on the loans. But if consumers cut back on the amount of spending due to high unemployment, increases in the savings rate, or as a result of the destruction of household wealth, the fees MA charges will likely be affected.
While consumer spending is difficult to predict on a month-to-month basis, logic tells us that the long-term trend is going to be flat to down. The US has consumer has been notorious for spending beyond his means, and while Mastercard has a strong international presence, the figures still show that over half of the company’s $28 billion purchase transactions occur within the US. Bulls will tell you that the expanding international scene will more than make up for the declines in US transactions, but that may turn out to be untrue – especially if we face another global economic recession.
The competition appears to be weathering the environment a bit better than Mastercard with Visa Inc. (V) logging stronger revenue growth even thought the company is already much larger than MA. Other card companies such as American Express (AXP) and Discover Financial (DFS) are more difficult to compare because these firms actually take on credit risk, collect interest payments, and are subject to write downs for bad loans to consumers and businesses.
Fundamentally, I am worried that Mastercard’s stock price has outpaced the company’s growth. At the end of the year there were 966 million cards issued which is actually a decline of 1.3% from the number of cards that were issued at the end of 2008. On top of that, the financial sector is likely not as healthy as many believe with both commercial and residential mortgage issues hanging over banks. Sheila Bair, Chairman of the FDIC states that there will be more bank failures this year than we saw during the crisis or as a result in 2009. These are the banks that issue additional cards to consumers and they are under significant pressure.
Technically speaking, Mastercard has rallied in March but with less vigor than the overall market. This relative under performance can lead to sharp declines whenever the broad market or specifically the financial sector begins to weaken. Traders should probably use the 50 day moving average as a good spot to initiate shorts when the stock closes below this level. Additional exposure could be added when MA crosses below the swing low of $216 logged in late February. I don’t think it’s unreasonable to expect the stock to trade down to $160 (roughly 12 time 2010 estimates) with the potential for much lower prices if investors become fearful.
The US stock market has been surprisingly strong for the past six weeks, and despite Friday’s breather, it is certainly possible for this trend to continue. Short positions should be placed carefully with proper risk controls, but in many cases adding short trades to a growth stock portfolio can increase returns while cutting down on the overall risk. For more information about building a balanced long/short approach to investing subscribe to the newly re-designed ZachStocks Newsletter and take advantage of the free trading and portfolio management tips.
FD: Author does not have a position in any stocks mentioned in this article.
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