(MA) MasterCard Analyst Keeps Shares at Neutral

We have reiterated our Neutral recommendation on MasterCard Inc. (MA) given the current sustainability factor. The company’s second-quarter operating earnings per share of $4.76 came in substantially ahead of the Zacks Consensus Estimate of $4.20 and $3.50 in the year-ago quarter. Net income for the reported quarter was $608 million, up 32.8% from $458 million in the prior-year quarter.

Results for the second quarter improved over the prior-year quarter primarily 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 the downside.

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 represent the key revenue drivers of MasterCard’s business. MasterCard continues to strengthen its business model through its latest strategic acquisitions of Travelex and DataCash.

Moreover, the debit card business continues to pose modest growth in a globally challenged 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 more promising growth opportunities from both geographic and product development perspectives. 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 long-term growth.

On the flip side, MasterCard is subject to stringent regulatory measures enacted in the U.S. in 2009 that have taken effect after the U.S. financial reform bill was passed in July 2010.

In June 2011, the Federal Reserve capped the interchange fees card networks that charge merchants on their debit card transactions to $0.21, substantially down against the average debit card interchange fee of $0.44 charged in 2009, under the provisions of the Dodd-Frank Act. This is expected to be effective October 1, 2011.

The drastic reduction will hamper revenues of the banks, which in turn will adversely affect the card companies as banks would now try to trim the fees they pay for using the respective card networks.

The Act also proposed that merchants will now have the choice of processing transactions through unrelated networks. This 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. Going foreward, the actual effect of these regulations coupled with the cycle of actions could turn out to be detrimental to growth in the upcoming years.

Additionally, MasterCard continues to face headwinds in maintaining the cost of operations of its vastly expanded business. While increased personnel costs due to severance-related charges are also on an inclining trend, the company’s expenses on rebates, incentives, legal, interest and other non-operating expenses continue to weigh heavily on the bottom line.

Weighing all the pros and cons amid the ongoing market volatility, the Zacks Consensus earnings estimates are anticipated to grow about 22% year over year to $4.82 per share in the third quarter of 2011, while for full-year 2011, earnings are expected to grow about 26% year over year to $17.69 per share. The quantitative Zacks Rank for MasterCard is #2, indicating a slight upward pressure on the stock in the near term.

Our six-month target price of $339.00 equates to about 19.2x our earnings estimate for 2011. We view the $0.60per common share annual dividend as secure, implying a total return of about 5.0% 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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