Is There Still Time to Get in on the Payment Processing Boom?

Matthew 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 one of the leaders in payment solutions, providing services related to credit, debit, and other payment methods for about 22,000 financial institutions. Shareholders of the company have done very well lately, with shares up more than 11% in the past three months alone. In fact, since first going public in 2006 at $39.00, shares are up an astounding 1,440%! With the company set to report its second quarter earnings on July 31, now seems like a good time to take a look at MasterCard and whether or not its shares are still attractive enough to own. We’ll also take a quick peek at some of MasterCard’s peers to see if our investment dollars could be put to better use elsewhere.

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The rise of MasterCard

MasterCard has been around since 1966 (then called Master Charge), but has grown tremendously over the past 15 years or so as the economy has become more and more cashless. MasterCard’s earnings have more than tripled in the past decade alone, and are projected to keep up this rate for the foreseeable future. What stands out the most to me about the chart below is the consistency of revenue growth, with the sole exception being the financial crisis years, when revenues still increased every year.

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In 2012, the company processed 34.2 billion transactions (including online), which is an increase of 25% from the year before. MasterCard has also made a considerable effort to expand its business globally since 2006 when it changed its name to MasterCard Worldwide, and those efforts have paid off, with about half of the company’s business currently coming from outside of the U.S.

Valuation and projections

Surprisingly, MasterCard seems to be reasonably valued, even after the tremendous gains in share price. Currently, shares trade at 23.5 times this year’s earnings estimates of $25.44 per share, and there is nice growth expected ahead. Due to a combination of 10% annual revenue growth, as well as higher margins resulting from lower operating expenses, the company’s earnings are expected to grow to $30.02 and $35.64 in 2014 and 2015, respectively. This represents annual earnings growth of 18% and 18.7%, which more than justifies the high multiple.

Although MasterCard’s dividend is not exactly impressive (0.40% annually), the company makes up for it in my preferred way of increasing value: share buybacks. When companies would rather spend their money on repurchasing shares, it tells me that they view their stock as being a good value, and a better way to grow than simply handing cash back to shareholders. Since 2010, the number of outstanding shares has dropped from 131 million to 121.6 million, a reduction of more than 7%. Yet another reason to love MasterCard is for its cash-rich balance sheet which features over $5 billion in cash and no long-term debt. 

However, compared to the company’s historic valuation, it is a bit expensive right now, so before we go jumping in, let’s take a look at some other options.

Other options: Visa and Discover

Visa (NYSE: V) is the world’s largest payment network and has grown similarly to MasterCard over the recent past. The two companies are also projected to have very similar growth going forward, and are comparable in most other ways. For example, Visa pays a low yield of 0.68% and has an excellent record of share repurchases. The company also has a cash-rich balance sheet, although not quite as impressive as MasterCard’s. 

In terms of valuation, Visa actually looks to be the more expensive option at 25.6 times 2013’s expected earnings. Visa reported its earnings last week, handily beating estimates, which caused a pop of over 3% and is partially responsible for the higher P/E.

Discover (NYSE: DFS) is a different type of payments company, offering credit cards and bank products on a direct basis to consumers in addition to providing payment services to merchants and banks. While Discover is the smallest and most speculative of the three, the company also has the most room for growth in its direct consumer finance business, as well as its payment network. Speaking of its payment network, Discover’s newly implemented partnership with PayPal is still in its infancy and could be very beneficial to both companies if successful.

Discover appears to be extremely cheap at just 10.1 times 2013’s expected earnings, but investors need to keep a few things in mind when considering the company. First, Discover is expected to invest more resources in growing its business, which is expected to lead to lower earnings growth (about 7% per year in the next few years). Additionally, Discover is not as cash-rich as the other two, but still has a solid balance sheet. On the positive side, Discover is the only one of the three that pays what I consider to be a significant yield (1.6%) and has the best buyback record of the three, reducing the outstanding share count by almost 11% over the past three years.

Buy, sell, or hold?

While MasterCard may seem a bit expensive at first glance, I think that shares are still fairly valued at this level. For those who have been invested since the beginning, it would completely make sense to sell at least some of your position and lock in profits. For new investors, my attitude toward MasterCard has shifted from “buy!buy!buy!” to “wait and see” after the dramatic share price gains of the past few years.  

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Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends 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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