Mastercard Stock (NYSE:MA)
Mastercard (NYSE:MA) is a high-quality company with a high multiple in the market. Given the current market environment, this multiple is not justified by its growth prospects. The market is not pricing in some risks to the company’s strong moat. Investors should remain neutral on this name until a better opportunity to purchase shares arises.
Growth Prospects Are Dim
Mastercard reported a 15% increase in revenue and a 14% increase in net income in their most recent quarter. Given the macro environment, these are solid figures. It’s challenging to see Mastercard maintaining this level of growth in the future, primarily because merchants are starting to push back on interchange fees. Mastercard’s inability to raise interchange rates removes a growth lever for the company. They may also be forced to reduce transaction fees, resulting in margin compression.
At the moment, Mastercard’s revenue and earnings are primarily determined by total nominal transaction value. The company is strong, but it has captured all of the market it can realistically achieve, and it cannot raise interchange rates any further. Mastercard is a stable and predictable company, but relying on spending growth carries some risks.
Long-Term Dangers
The market believes Mastercard has a strong moat, but some potential threats are on the horizon.
Legislative scrutiny poses a significant threat to Mastercard and Visa (NYSE:V). Legislative pressure grows as more merchants criticize the companies for the amount of each transaction they accept. Regulators dislike the major card networks and will likely take more action against them over the next decade. This should reduce the premium that the market charges card networks.
Crypto payment networks threaten the major card networks because they seek to bypass their payment system entirely and, in many cases, traditional financial institutions. I’ve never been a fan of cryptocurrency, but it is undeniably a threat to payment networks.
In recent years, buy now, pay later payment options have grown in popularity. People can use BNPL companies to spend money now and pay for it later in installments through their bank accounts. This completely avoids the card networks. While this concept has been tried before and does not appear to be a viable business model, any potential decrease in transaction volume due to a shift in societal preferences poses a risk to Mastercard.
Margin compression is a major risk that could arise from various sources. Regulatory scrutiny and competitive pressures are the two most significant sources of potential margin compression. If governments worldwide take action against card networks, they may be forced to lower their fee rates. If retailers and consumers have many options, card networks may need to make themselves more appealing by lowering fees or increasing incentives. This would likely result in margin compression in the long run.
Price Movement
Mastercard has performed admirably over the last year and is now in the black. Even though we do not consider Mastercard a “buy,” we think the company is a solid component of a diversified portfolio. Investors can feel comfortable holding the stock. We do not believe it is a good time to add shares, given the current market premium and the abundance of better opportunities.
Mastercard stock is trading at a forward PE of 31.12 and a trailing PE of 37.75. This appears to be relatively inexpensive compared to recent history, but the risks to Mastercard’s business are greater than they were previously.
Given that the S&P 500 is currently trading at a PE of 20.65, Mastercard is presently overvalued. Their growth potential and risk profile do not justify a nearly double the market multiple. We believe Mastercard should trade at only a 50% premium for the following reasons.
- Mastercard is a reliable company that deserves a higher multiple.
- Investors should also be wary of the possibility of lower growth and an increase in risk in the future.
Taking these two statements into account, the risk/reward ratio is currently unfavorable, but current shareholders should do well.
Neutral Thesis Risks
Because our thesis is neutral, there are risks to both the upside and the downside.
In terms of upside potential, Mastercard may find a way to diversify its business or significantly improve its revenue growth and margins with the current model. This would imply that Mastercard’s moat is stronger than expected and that it will outperform our expectations.
Some downside risks include deteriorating Mastercard’s business and the inability to deal with enormous pressure from regulators and competition. If Mastercard cannot maintain its moat and high margins, investors will no longer be willing to pay a premium multiple for the company.
Bottom Line
Mastercard is a solid company, but we would not add shares now. The current valuation assumes high expectations, but Mastercard may be unable to meet those expectations in the future. This is a name that investors should keep an eye on and look to buy some shares of Mastercard stock when the risk/reward ratio becomes more appealing.
Featured Image: Pexels @ Pixabay
