Introduction

We review our investment case on Mastercard (MA) based on the latest volume data released on Tuesday night (November 24) and other developments since our last update in September.

Since we initiated our coverage with a Buy rating in March 2019, MA shares have returned 46.5% (including dividends). During 2020 year to date, MA shares have returned 15.2%, outperforming the S&P 500 index, was far ahead of “value” play American Express (AXP) but was behind PayPal (PYPL) (whose shares have risen around 90%):

The move to digital payments is a strong secular trend, and we also have Buy ratings on Visa (V) and PayPal and enjoyed strong gains there; we have been Neutral on American Express, which underperformed as expected.

Steady Volume Trends in November

MA’s year-on-year volume growth, including for the last 4 weeks (up to the week ending November 21), is shown below:

MA Switched Volume Growth Y/Y (Constant Currency) (Since March 20)

NB1. Figure for w/e 14 March is for 2 weeks; no separate data for w/e 28 June. Only September full-month figures available; assume flat trend through the month.

Source: MA company filings.

MA’s global volume in the last 4 weeks was “relatively steady”, averaging a year-on-year growth of about 3% across this period. (The spike in the week ending October 21 was due to “significant promotional activity by an e-commerce merchant and its competitors”, likely Amazon Prime Day on October 13-14).

U.S. volume growth was higher, averaging mid-single-digits, with “some recent strength” in U.S. holiday spend, while non-U.S. volume growth has averaged about 1%, with a “slight decrease” in European Travel & Entertainment (“T&E”) and retail due to COVID-19 restrictions having been reintroduced in several key markets, including the U.K., France, and Spain from late October onwards.

The steady volume trends so far in November, despite the resumption of COVID-19 restrictions in key markets, should be reassuring for investors.

Total cross-border volume improved slightly in November, “largely” due to an improvement in lower-yield intra-Europe volume. Other cross-border volume “remains limited”, at 42% lower year on year, in the 3 weeks to November 21.

Cross-Border: Limited Travel, but Strong E-Commerce

This chart shows cross-border volume growth year on year in more detail:

Total cross-border volume growth was slightly better in November than in October, as explained above. Within this, Card Present growth was slightly worse, and Card Not Present growth was slightly better, reflecting the return of COVID-19 travel and social distancing restrictions in key markets.

However, “Cross-border Card Not Present (Non-Travel)” volume (in green above) has been consistently higher than the prior year by between 20% and 40% since the start of the outbreak, showing the strong growth in e-commerce that has also benefited cross-border volumes.

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Recap on Q3 2020 P&L

As MA volumes have continued on the same trends as last quarter, we revisit the company’s P&L for Q3 2020; Q4 will likely be similar.

For Q3 2020, Gross Dollar Volume grew by 1% year on year globally, including by 4% in the U.S. and staying flat in non-U.S. (excluding currency). However, cross-border volume was 36% lower year on year, and 49% lower, excluding lower-margin intra-Europe volume (which was 23% lower). The P&L that was generated as a result is shown below:

The large decline in cross-border volume meant a 48% decline in cross-border volume fees and a 14% decline in total revenues, even as other revenue lines grew. “Other Revenues”, in particular, was up 6% year on year (4% excluding acquisitions), showing customer demand for MA’s value-add services even amid the widespread cost cuttings during the COVID-19 outbreak.

Operating expenses fell 5% year on year (8% excluding acquisitions), partially offset the lower revenue, but EBIT was still 20% lower year on year (with margin falling 420 bps), and EPS was 25% lower year on year.

However, Q3 2020 did represent a strong rebound from the trough in Q2, with revenues being 15% higher and EBIT being 22% higher sequentially.

Management is still not giving forward guidance on revenues, due to ongoing uncertainties around COVID-19 and the economy. While recent volume trends were slightly better than those in Q3 (up 3% vs. up 1% in Q3), we expect Q4 revenues to be only slightly better than Q3. Management has guided to Q4 expenses to be down low-single-digits, excluding acquisitions and currency, but up low-single-digits including them. Base on all of these, we expect MA’s EBIT to show a 25% year-on-year decline in Q4 2020.

Full Recovery During 2021 Now In Sight

Notwithstanding short-term headwinds, we believe a full recovery at some point during 2021 is now in sight.

MA’s business fundamentals remain strong. Total volume has already recovered to being 3% higher year on year, with spending being supported by government stimulus programs and MA’s share of this, helped by the acceleration in e-commerce and digital payments. In fact, as of September, growth in ex-T&E volume was already back to the pre-COVID-19 levels seen in Q4 2019. MA’s revenue and earnings are suffering a disproportionate impact due to type of volume it now has, with COVID-19 restrictions having shifted it away from high-margin T&E and cross-border categories.

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With multiple vaccines now potentially to be available from early 2021, the end of COVID-19 and a recovery in T&E as well as cross-border travel are now in sight. MA looks to the “latter part” of 2021 as the likely point at which vaccines and therapeutics will re-ignite cross-border travel, as the CFO stated:

“The impact of the pandemic on travel and, in particular, on non-intra-Europe cross-border travel, remains significant. While we believe that cross-border will ultimately recover, it will take time for people to build their confidence in the safety of travel, and we believe that is tied to the broad availability of vaccines and therapeutics, likely towards the latter part of next year.”

Sachin Mehra, MA CFO (Q3 2020 earnings call)

One factor in MA’s favour is that personal travel is a “substantial portion” of MA’s cross-border volume and will likely recover faster than business travel.

While there may be a period of economic weakness in the aftermath of COVID-19, depending on the extent and duration of further government stimulus measures, MA’s growth will continue to be helped by the acceleration in digital payments, as well as by a one-time boost from pent-up T&E demand.

Other Developments

Other developments since our last update included:

  • The $3.2bn Nets account-to-account payments platform acquisition, originally announced in August 2019, did not close in Q3 2020 as originally expected, despite having received conditional approval from the European Union in August 2020. It is now expected to close in Q1 2021
  • The $825m Finicity acquisition, announced in June 2020, is expected to close during Q4 2020; approval from the U.S. Department of Justice was received during November
  • MA expanded its involvement in Buy Now Pay Later (“BNPL”) by announcing a partnership with TSYS in September, which will allow TSYS to be the first processor to provide installment capabilities to card issuers. MA is developing a BNPL “ecosystem”, and already has other partners including Splitit (OTCPK:STTTF) (global), Jifiti (North America), Divido (Europe) and Pine Labs (Asia Pacific)

Valuation

At $342.39, relative to 2019 financials, MA shares are trading at a 43.4x P/E and a 2.1% Free Cash Flow (“FCF”) Yield; the Dividend Yield is 0.5% ($1.60):

MA Net Income, Cash Flows & Valuation (2016-Q3 2020)

Source: MA company filings.

MA shares have re-rated upwards by about 20% since our March 2019 initiation, when they were trading at 36.3x 2018 EPS. However, strong EPS growth (20% in 2019) also contributed a substantial part of our gain.

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MA remains highly cash-generative. During Q3 2020 year to date, it generated an FCF of $4.2bn, only 5.4% lower year on year, partly thanks to lower working capital outflows.

Share buybacks were resumed at the end of Q2, and $2.1 billion of shares were repurchased during Q3 (at an average price of around $308), with another $392m repurchased by October 23.

Illustrative Return Forecasts

We reduce our 2020 and 2021 estimates slightly but leave most other assumptions unchanged, including:

  • 2020 Net Income to be $6.40bn (was $6.75bn), 21% lower year on year, including a 25% year on year decline in Q4
  • 2021 Net Income to be $8.14bn (was $8.33bn), being flat from the Q3 2020 level ($1.6bn) in Q1 and Q2 of 2021, but then being 15% higher than the 2019 level in Q3 and Q4
  • Thereafter, Net Income to grow at 15% (was 14.5%) each year
  • Our new 2023 Net Income figure is $10.76bn (was $10.93bn)
  • Share count to fall by 1% each year
  • Together, these give a 16% EPS CAGR from 2022, in line with pre-COVID-19 management target of “high teens”
  • Dividend to be $0.40 per quarter for 2020 and then grow with EPS on a 20% payout ratio
  • 2023 year-end P/E of 42x, a small de-rating from the current 43.4x, and implying a 0.5% Dividend Yield at exit

With shares at $342.39, these imply a total return of 36% (10.0% annualised) by 2023 year-end, in just over 3 years:

Illustrative Mastercard Returns

Source: Librarian Capital estimates.

Conclusion

Mastercard’s latest volume data for the last 4 weeks was reassuring, showing “relatively steady” trends from Q3 2020.

Global volumes remained about 3% higher year on year so far in November, despite the resumption of COVID-19 restrictions in key markets.

Cross-border volume has stayed at the same level as Q3, due to continuing travel restrictions, except in low-margin intra-Europe volume.

We expect EBIT will show a 25% year-on-year decline in Q4, but the end of COVID-19 is now in sight, and travel is expected to recover in H2 2021.

At $342.39, Mastercard shares can deliver a total return of 36% (10.0% annualised) in just over 3 years.

We reiterate our Buy rating.

Note: A track record of my past recommendations can be found here.

Disclosure: I am/we are long MA,V,PYPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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