Profiting on Mastercard’s Results

By Tim Brugger - May 2, 2012 | Tickers: DFS, MA, V | 0 Comments

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So much for announcing a great quarter. By virtually every measure that counts Mastercard (NYSE: MA) posted fantastic results earlier. Earnings, revenues and card usage were all significantly higher. The result has been a sell-off. It’s likely the slightly disappointing job numbers are to blame for much of the day’s decline, but this too shall pass.

For investors the question is this - does the easing in share price equate to Mastercard being a buy? You could do a lot worse sure, but you can also do even better.

First, the Numbers

As we run through Mastercard’s quarterly results it’s worth reviewing the information with the industry as a whole in mind. If ever there was an industry that moved in concert, consumer financial services is one of them. Sure, there are always idiosyncrasies and we’ll see an example shortly, but by and large the industry moves in tandem.

With that said, Visa (NYSE: V) won’t announce its results until after the close, but it would be surprising if the $98 billion behemoth doesn’t follow Mastercard’s lead and post solid growth across several areas.

For Mastercard  the number two credit card company in the land - net income for the quarter came in at a stellar $5.36 a share. That compares with $4.29 a share in the year-ago period and $5.30 vs. analyst guesstimates. Revenues were also up in a big way, and crushed last year’s results, once again beating expectations as well. The $1.8 billion in revenue the company posted was a 20% jump over last year. And card usage was also up – both domestically (14%) and even more impressively overseas by over 20%. Both are great indications of consumers getting out and spending, which supports the slowly improving economic data and is a positive for the entire industry.

The Opportunities

Again, softer than expected job numbers are the probable culprit for the drop in Mastercard's share price after such a great quarter, but that may not be all. By virtually every measure imaginable both Mastercard and Visa are overly bought. Based on earnings multiples, Visa and Mastercard are one/two respectively cost-wise. Price-to-sales and price-to-book also position the two leaders near the top of the list of expensive options in the sector. Now, as leaders much of that is to be expected – plus both have outstanding debt-to-equity ratios and their margins are off the charts.

But there’s another opportunity that’s even better than it was toward the end of last year, and it was good then. At the time the trend toward an improving economic environment – particularly consumer confidence and spending – lent itself toward all things credit. Just as was the case then, Discover Financial (NYSE: DFS) remains the best value in the industry – bar none. Why is it so cheap you ask? A couple of things - one less-than-redeeming attribute is a considerably high debt ratio than the other two big boys. The other is investors weren’t overly impressed with last year’s purchase of Citi’s student loan portfolio and the on-going discussion by politicos regarding student loans, defaults, and possible forgiveness certainly hasn’t helped either.

But with all that there’s simply too much to like for Discover to be ignored any longer. Lower loan provisions speak to a better quality portfolio – there’s that macro data again because that's an across the board improvement – and a much higher return on equity, the company is coming off a stellar quarter and is likely to do so again, and at a miniscule 7.8 times earnings it is ridiculously cheap.

Even as Discover Financial bounces off resistance at it’s 52-week high this stock is poised to break through and settle in near the low $40’s.

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