Mastercard Is Ready To Capitalize On Cashless Trend

Jonathan Ball |

July 19, 2019

The payments industry is being driven by two trends: contactless credit cards and the move to a cashless society.

MasterCard has been riding that wave to higher revenues and big gains in stock price.

MasterCard's return on equity is four times that of Visa.

Two merging trends, the increased use of contactless credit cards and the growing belief that society will become cashless, have propelled MasterCard's (MA) stock to new heights. The payments industry is still in the early innings of this new game, and MasterCard is well positioned to capitalize on the changes.

Currently 82% of Millennials believe society will eventually become cashless, according to a TD Bank Consumer Spending Index. That's unlikely to happen any time soon, but people are increasingly using cards for smaller payment amounts. A report from payments and business services company Square (SQ) said that in 2019, for transactions under $20, consumers paid with cash only 37% of the time, a 9-percentage-point decrease from the 46% cash usage in 2015. And this will only decline as more people use their phones to pay for things.

Part of that drop in cash payments comes from the increased adoption and ease of contactless credit cards, which are replacing swiping or inserting plastic. While the U.S. has adopted contactless payments at a slower pace than other countries, both MasterCard and its top competitor, Visa, have been riding that wave to higher revenues and big gains in stock price.

MasterCard's stock is up 47% year-to-date and more than 200% over the past three years. The global electronic payments processor, based in Purchase, N.Y., will continue to benefit as the transition from cash to plastic accelerates worldwide.

Last year, MasterCard's revenues jumped 20% to $15.0 billion. Adjusted net income surged 39% to $6.9 billion, or $6.49 a share. For the first quarter of 2019, the company reported revenues climbed 8% to $3.9 billion. Adjusted net income leapt 13% to $1.8 billion, or a $1.78 a share.

The company reports second-quarter earnings on July 30. Thomson Reuters has a consensus earnings estimate of $1.83 a share for the second quarter. For the full year, the earnings estimate is $7.63 a share, an 18% increase from 2018. Earnings are expected to grow another 18% in 2020 to $9 a share, and 19% in 2021 to $10.69 a share.

Bryan Keane, an analyst at Deutsche Bank, raised his price target on MasterCard to $330. Currently the stock is trading at a price-to-earnings ratio of 35. If you multiply that by the $9 earnings forecast for 2020, you get to $315. If you multiply it by the $10.69 a share estimate for 2021, I get a price target of $374.

Operating margins came in at 57% last year. Value Line forecasts operating margins of 58.8% this year, and 62.5% in 2020.

Both MasterCard and Visa (V) have similar business models. They let banks, credit unions, or other financial institutions issue cards with the payment processor's branding on the cards. They then process the payments and transactions between cardholders at point of purchase and the merchant.

With a network in place consisting of merchants, consumers, and banks, there is a high barrier to entry into the payments industry. That network is defended by a moat of regulation, security, and fraud protection that no technology company wants to deal with, Lisa Ellis, payments analyst at research house MoffettNathanson told Barron's.

On average, both Visa and MasterCard take in just 15 basis points, or 0.15%, per card transaction, according to estimates by Morgan Stanley analyst James Faucette. The low fee decreases the incentive to displace Visa and MasterCard. Yet, the fee brings in huge amounts of cash because of the enormous volume that flow through the networks.

Last year, Visa did $11.2 trillion in total payment volume on 3.3 billion cards outstanding, while MasterCard did $5.9 trillion in payment volume with 2.5 billion cards outstanding.

The Nilson Report, a leading payments trade journal, estimates that the global purchase volume of credit, debit, and prepaid cards will rise to $78.5 trillion by 2027 from $23 trillion in 2017, according to Barron's

About 43% of global consumer purchases were made on cards last year, up from 28% in 2010, according to MoffettNathanson, putting the increase at about two percentage points annually.

In 2018, Visa and MasterCard had 57% and 30%, respective shares of the global card purchase volume, excluding the Chinese market, versus 8% and 1% for American Express and Discover, according to MoffettNathanson estimates

So, why pick MasterCard over Visa (V)? Because, MasterCard's return on equity last year was 125%, while Visa's was 32%.

As people stop using cash, the move to electronic payments will be the growth driver for both companies. Compared with China, the U.S. is far behind in terms of digital payments. This means the U.S. is a huge opportunity for MasterCard.

Earlier, this year, Apple (AAPL) announced it would launch the Apple Card credit card, which would be linked to Apple Pay and integrated into the iPhone Wallet app. It would also offer tools to help users manage their spending. The card is a joint venture with Goldman Sachs (GS) and it will use MasterCard's network. With the Apple Card expected to launch this summer, the partnership will give MasterCard a leg up with digital payments in the U.S.

Finally, MasterCard's float is being reduced by 10% every five years. In December, the company announced a new share buyback program. It plans to repurchase $6.5 billion worth of common stock as soon as it finishes the $4 billion buyback program it started in 2017. It also raised the annual dividend 32% to $1.32 a share.

Disclosure: I am/we are long MA.