Analyzing Mastercard Inc.'s (NYSE:MA) shares from the point of view of its business model and its fundamental indicators shows the company is of extremely high quality. The consolidated business model and very high competitive advantages allow for high margins and a substantial generation of free cash flow and, consequently, returns to shareholders through dividends and buybacks.
Despite this, Mastercard's stock currently trades at high multiples that look overvalued at first glance. Its price-earnings ratio is now 34.40, while the forward price-earnings ratio is 30. The price-to-free cash flow ratio of the last 12 months is 30, giving us a yield of just 2.60% per year. Even so, I believe Mastercard's shares are still interesting to keep in the portfolio.
A high-quality business modelAs mentioned, Mastercard has an extraordinary business model centered on serving small business owners up to governments with payment methods and taking a fee from each transaction. Building this entire network requires years of effort in investments, partnerships and more, which is a significant barrier to entry. To illustrate this, the company has been investing and innovating in this industry since it was founded in the mid-1960s, and this industry is so reliable and essential today that it is hard to imagine a world without it.
That pretty much sums up Mastercard's competitive edges, but to break it down a little further, this extensive global network present in a number of countries around the world is beyond description. Its partnerships, which have been built up over years of investment, have already won the loyalty of partners and customers who use the cards, trusting the transaction will be secure, fast and can offer certain advantages. All this has led to a large moat being built up, which can be considered a duopoly between Mastercard and Visa (NYSE:NYSE:V), as well as a profitable model that requires little capital to run and to grow.
This allows the company to maintain a 46% net margin and 41% free cash flow margin as well as a return on invested capital of over 42%. This gives the company a perfect score of 10 out of 10 for the GuruFocus profitability rank. To illustrate this, in more than $1.60 billion was generated in operating activities during the first quarter, while investments in property and equipment were $157 million and a further $221 million was earmarked for capitalized software, leaving plenty of cash to allocate to other resources.
Source: GuruFocus
Most of this returns to the shareholder in a number of ways. In the first quarter, the company repurchased $1.99 billion worth of shares and paid out $616 million in dividends. The company has consistently repurchased shares as well as distributed dividends, which have averaged 0.54% over the last three years. The most interesting thing is the compound annual growth rate of the dividend per share has been 21.90% over the past decade, increasing consistently and in a healthy way, since the payout has remained very controlled over these years, always below 50% distribution and with an average payout over the last 10 years of 19.50%.
Source: Koyfin
Mastercard's prospects and the marketThis means that if Mastercard can keep its revenue growing at the same rate and its margins high, even at the current valuation, it is a great deal. In the first quarter, the company maintained these very positive fundamentals with Payment Network net revenue advancing by 7% quarter over quarter on the back of higher volume and switched transactions. In addition, value-added services and solutions net revenue increased by 16%, impacted by the continued demand for Mastercard's consulting, marketing, loyalty and anti-fraud/security solutions.
Even though it has already grown a lot and has a relevant market share (37.50% in the U.S., second only to Visa) in a consolidated market, the secular trend of this market should continue to drive Mastercard. The Credit Card market alone, according to Skyquest, is projected to grow at a rate of 7.78% per year until 2030, reaching $961 billion in that period. Thinking that Mastercard is one of the companies benefiting from this, and still has room to grow on other fronts (mainly "value-added" services), it is reasonable to project the company will be able to maintain a net profit CAGR of at least 10% over the next decade (which would be approximately 8% from the growth of its market and 2% from options, efficiency gains and perhaps market share capture).
Although this trend is secular, it should be mentioned that in some countries, such as Brazil, the use of other tools such as Pix (a means of payment created by the Brazilian Central Bank) has already overtaken the use of credit cards, which, although widely used, can be an uncertainty for this growth that is often taken for granted.
It is also worth mentioning that although there are other players in the sector such as Visa, which is very dominant, and other incumbents such as Discover and JCB, I think the prospects for Mastercard are interesting since these competitive advantages and its already solid position should guarantee stability against threats and perhaps the conquest of some more market share, either by taking over from Visa and smaller players or via acquisitions.
A premium valuationOver the last 10 years, Mastercard's average price-earnings ratio was 31.50, while the median was 30. This means the 30 times it currently trades at is not seen as such an exorbitant level since it is within the average, but it reinforces that the company was and is traded at a premium valuation due to its high predictability, business model with clear competitive advantages and high profitability.
But for these prices to make sense, Mastercard must continue to deliver growth.
In a reverse discounted cash flow model, to arrive at the assumptions the market uses to price Mastercard's stock, some very optimistic assumptions are built in, such as a growth rate of 15% per year in the first 10 years, followed by 13% per year in the terminal stage (second decade) and discounted by a discount rate of 8%, all to get the current price. In other words, if the shares deliver growth of 15% over the next few decades, followed by 13%, at current prices the investor would get a return of 8% per year. This seems OK for a defensive stock, given its high predictability and the possibility of positive surprises (bearing in mind the company may be able to maintain a growth rate of over 15% per year in free cash flow).
It is undeniable that for a value investor, this narrow margin of safety is uncomfortable. As the projected growth is already very optimistic, I believe that, however probable it may be, a slightly better margin of safety is needed since in pessimistic scenarios it wouldn't be difficult to imagine a company growing closer to 10% instead of 15%. With 12% growth in the first decade (a figure I took arbitrarily just to prove a point) and keeping the other assumptions constant, there would be a downside of 24%.
Source: GuruFocus
In any case, I believe this 24% downside scenario is unlikely and, as the company has a lot of quality, a premium valuation is really necessary. The roughly $400 billion market cap seems to be a justified valuation, reasonable and close to the fair value, and not a bad choice for investors who like a cash cow and a defensive position.
The bottom line My take is that Mastercard will maintain both the premium in its multiple and its growth. That is why I think it is an interesting stock for those who want to add a more defensive position to their portfolio.
The predictable projected growth together with the robust volume of free cash flow, which is reflected in a volume of buybacks and dividends that, although not as high in relation to the market cap, are growing at an accelerated pace, makes it a true cash cow, which will possibly deliver an attractive yield on cost in a few years.