1 Credit Card Stock to Buy, 2 to Avoid

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

While retail is often the first way investors choose to bet on a quicker-than-expected recovery, cards are not bad either. While I believe the recovery has been excessively sluggish, Amex, MasterCard, and Visa have positioned their own cards well in preparation. In some instances, however, the market has exaggerated the positives of the fundamentals and casted aside management uncertainty. I believe in backing firms that are making partnerships with key retailers while delivering better-than-expected results.

Amex (NYSE: AXP): Buy This Card For Top Returns

Amex is one of my favorite picks as a way of betting on a strong recovery. After rising 35.4% over the past 12 months (nearly 950 bps greater than the S&P 500's return), prospective investors may fear that they are too late to the punch bowl. However, the economy is just starting to move towards a full recovery, and the accompanying upside has yet to materialize in the form of increased consumer confidence.

The company recently partnered with the world's largest retailer, Wal-mart, to introduce "Bluebird," a service that enables consumer to pay bills through mobile and smartphones without a debit and checking account, at no annual or monthly overdraft charge. This will appeal to more of a low-income market and help Amex expand its core premium market. It also sets the company up for a move in banking and check writing.

Perhaps most importantly, consumer spending increases have been particularly magnified at Amex. Billed business grew 9% sequentially in the recent quarter, loan delinquencies declined 30 bps to 1.2%, and net charge-offs fell 1% y-o-y. The adoption of Europay Visa (NYSE: V) and Mastercard (NYSE: MA) cards domestically will also help it gain market share through improved merchant acceptability. But the pressure may increase as MasterCard and Visa try to implement merchant card surcharges, which has hitherto been an exclusive revenue stream for Amex. All in all, Amex has the best of both worlds: increasing consumer confidence, high fees, and affluent customers who are more recession proof than most. At a free cash flow multiple of 5.9x, Amex is definitely worth an investment.

MasterCard & Visa: Not Worth The Multiples

Then there are stocks that are simply too expensive. Visa trades at 19.4x forward earnings, versus 18.4x for Mastercard.  Over the last six months, Visa has outperformed the latter by 730 bps for a return of 14.6%. And while both have strong brands, the fundamentals do not merit this premium to the broader S&P 500. Second quarter performance was strong for MasterCard, with 9% revenue growth being driven by greater volume and transaction - yet, there was a disappointing amount of deceleration from the preceding quarter in SpendingPulse data. Perhaps most disappointingly, management has been tepid on Asia - explaining that there is a slowdown in China and India. As a whole, management stated that it was cautious for the rest of 2012.

JPMorgan, however, has argued that MasterCard and Visa will generate higher capital returns to shareholders due to little future capital expenditures and acquisitions. While it is true that both have $5 billion worth of unrestricted cash to return to shareholders, they both operate in mature markets and have limited growth opportunities, aside from natural macro cyclicality.

I find that analyst forecasts for 19.6% annual EPS growth in Visa and 18.8% in MasterCard to be simply unreasonable when only 10.3% is forecasted in Amex. This irrational difference is partially responsible for the multiples spread and, in my view, as the economy recovers this will become apparent to the market and start to close. Accordingly, I recommend buying Amex over MasterCard and Visa.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of MasterCard and has the following options: short OCT 2012 $55.00 puts on American Express Company, short OCT 2012 $60.00 calls on American Express Company, and long OCT 2012 $65.00 calls on American Express Company. Motley Fool newsletter services recommend American Express Company and Visa. 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.If you have questions about this post or the Fool’s blog network, click here for information.

blog comments powered by Disqus