Big Long-Term Potential for This Global Powerhouse

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

MasterCard (NYSE: MA) is firing on all cylinders lately, the stock is trading at all-time highs after delivering a blowout earnings report for the last quarter. Valuation may be getting a little frothy but, make no mistake; this global payments powerhouse still has plenty of upside potential for years to come.

Business Model

There are basically two kinds of card companies with very different business models, players like American Express (NYSE: AXP) and Discover Financial (NYSE: DFS) are involved in the lending business, and this has some important implications to consider, both positive and negative.

These businesses get a double boost when things are going well since they profit at the same time from growing consumption and expanding credit demand. Consumers in the U.S. have come a long way in terms of streamlining their financial position over the last years, and both American and Discover are showing healthy credit performance over the last few quarters.

While American wrote off only 2.2% of principal, interest and fees in bad loans during the last quarter, Discover charged off 2.34% during the same period. Credit risk seems to be under control, and these companies will likely benefit from rising demand for loans in the middle term.

However, credit exposure can be a double-edged sword as investors painfully learned during the 2008-2009 financial crisis, when American and Discover suffered massive losses due to the credit crunch. Even if credit quality will likely continue improving over the coming quarters, these businesses are exposed to credit risk on a long-term basis, and this will always represent a potential source of uncertainty for investors.

On the other hand, companies like MasterCard and Visa (NYSE: V) simply charge a fee for every transaction done via their payment networks, all financial risks for their credit cards lie with the issuing bank. This means more transparency regarding balance sheet health, and international growth is also much easier for these companies because they don´t need to worry about their customers' creditworthiness.

The business model is very efficient; once the company has built its network and technologies, revenues tend to rise faster than expenses, and this has a positive impact on profit margins. MasterCard delivered sky high operating margins of 58.6% for the last quarter.

Global Growth

MasterCard has a global market share of around 31%, second only to Visa, which owns 63% of the market.  Visa´s dominance, however, is due mostly to its higher market share in the US. In international markets, where the best opportunities for growth can be found, MasterCard is outgrowing Visa.

MasterCard reported a growth rate of 15% annually in international markets gross dollar volume for the last quarter. Key emerging markets like APMEA – Asia Pacific Middle East and Africa – and Latin America were particularly strong with an annual growth rate of 18.8% and 17.5% respectively.

Visa is still doing pretty well, but falling behind MasterCard in those regions with a growth rate of 10.5% in Asia Pacific and 9.9% in Latin America during the quarter.

MasterCard makes more than 60% of revenue from international markets, and this means superior growth prospects for the company. Higher economic growth will have a big impact on the volume of processed transactions over the next years, and these markets are significantly underpenetrated when it comes to all kinds of financial services.

Cash still accounts for a whopping 85% of transactions around the world, as economic development increases access to banking and financial services in emerging markets, plastic will continue replacing paper money in these countries, and MasterCard is in a privileged position to benefit from such a powerful secular trend.

 Competitive Strength

Brand recognition is of utmost importance in the payments industry, trust and reliability are key competitive assets for a company. The MasterCard brand is globally known thanks to marketing initiatives like the memorable “Priceless” campaign, so consumers around the planet know they can purchase almost anything, anywhere, with a MasterCard card.

Companies in this business benefit from the network effect: merchants need to accept those cards which bring more customers to the business, and customers want to have a card that is widely accepted. MasterCard has built a gigantic global network connecting clients and merchants all over the planet, an asset thatwould be very hard to replicate by potential competitors.

Growth and Valuation

At a forward P/E above 21, MasterCard is getting a bit pricey, but this kind of growth doesn´t come cheap. The company expects to deliver a compounded annual increase of between 11% to 14% in revenue from 2013 to 2015, and management is forecasting a growth rate of at least 20% in earnings per share for the same period.

This sounds like a very achievable target considering that the company produced an increase of 15% in revenue and 23% in earnings per share during the last quarter. MasterCard has plenty of room for growth, especially in emerging markets, so current valuation shouldn´t be a limitation for long-term investors willing to hold to this high quality company for years to come.

Bottom Line

MasterCard has a transparent and enormously profitable business model, strong growth prospects in emerging markets and the competitive strength to capitalize its opportunities. Even at historical highs, this global payments powerhouse has plenty of upside potential.

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Andrés Cardenal  owns shares of MasterCard. The Motley Fool recommends American Express, MasterCard, and Visa. The Motley Fool owns shares of MasterCard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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