(MA) MasterCard Intact at Neutral

We reiterated our Neutral recommendation on MasterCard Inc. (MA) given the current sustainability factor. The company’s first quarter operating earnings per share of $4.29 came in significantly ahead of the Zacks Consensus Estimate of $4.10 and $3.46 in the year-ago quarter.

Results for the reported quarter improved over the prior-year quarter mainly due to better pricing, an increased number of processed transactions, strong gross dollar value (GDV) growth and a lower tax rate that also drove the operating margin. However, increase in rebates and incentives and higher operating expenses were on the downside.

More significantly, regulatory measures enacted in the U.S. in 2009 have taken effect after the U.S. financial reform bill was passed in July 2010. In December 2010, this consumer protection Act proposed that the interchange fee on debit transactions, charged by banks on the merchants, should be restricted to about 7–12 cents, against the average debit card interchange fee of 44 cents charged in 2009.

This profound slashing will hamper revenues of the banks, which in turn will adversely affect the card companies as banks would now try to trim the fee that they pay in order to use the respective card networks. The Act also proposed that merchants will now have the choice of processing transactions through unrelated networks.

Such regulations may hamper the number of transactions processed, coupled with the cost of such transactions, which is again a key growth component for the card companies. Moreover, a part of these costs will be shifted to the consumers, which tend to shrink consumer spending and risks a decline of transaction and payments volumes through its systems.

While the Federal Reserve is expected to come out with a final rule on capping debit interchange fee on June 29, the cycle of actions could turn out to be detrimental to the growth potential in the upcoming years.

Furthermore, currency fluctuations along with higher rebates and incentives passed on to the customers and intermediaries also added to the woes. Although, the GDV growth is recovering, uncertainty prevails over the consistency to significantly support the company’s top-line growth in the near future.

On the flip side, MasterCard continues to drive growth through increased cross-border volumes and improved pricing coupled with consistent growth of processed transactions. These signs are encouraging as they account for key revenue drivers of MasterCard’s business.  Besides, MasterCard continues to strengthen its business model through the recent strategic acquisitions of Travelex and DataCash.

Moreover, the debit card business continues to pose modest growth amid the global challenging environment. Further, MasterCard is also expected to gain from the adverse impact of financial reform on Visa Inc.’s (V) debit card business in the long run.

The company is also diversifying its product portfolio through innovations that include e-commerce, mobile payments and smart cards in order to realign itself to capitalize on the most promising growth opportunities from both a geographic and product development standpoints. Such long-term growth strategies are also required for sustaining competitive pressures, primarily from Visa and American Express Co. (AXP).

Additionally, MasterCard enjoys a strong cash, investment and operating cash flow with no long-term debt. This not only provides an operating leverage to the balance sheet but also provides acquisition opportunities as well as scope for liability reduction, acquisitions, stock repurchase and capital expenditure that will in turn enhance the long-term growth.

Based on the above factors, the Zacks Consensus earnings estimates are anticipated to grow by about 20% year over year to $4.20 per share in the second quarter of 2011, while for full-year 2011, earnings are expected to grow by about 21% year over year to $17.02 per share. The quantitative Zacks rank for MasterCard is #3, indicating no clear directional pressure on the stock in the near term.

Our six-month target price of $288.00 equates to about 16.9x our earnings estimate for 2011. We view 60 cents per common share annual dividend as secure, implying a total return of about 5.2% over that period. This is consistent with our long-term Neutral recommendation on the shares.

AMER EXPRESS CO (AXP): Free Stock Analysis Report

MASTERCARD INC (MA): Free Stock Analysis Report

VISA INC-A (V): Free Stock Analysis Report

Zacks Investment Research

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