Mastercard or Visa (or Paypal?)

[ADrunkenMarcus]

I'm running some numbers on Visa and Mastercard (Sharepad).

The most recent year has:

Operating margin:
Visa: 65.1%
Mastercard: 53.9%

Return on Capital Employed:
Visa: 22.8%
Mastercard: 56.2%

Cash Return on Invested Capital:
Visa: 20.4%
Mastercard: 42.8%

The ten-year average numbers show the same relationship: Visa's operating margin somewhat better than Mastercard's, but Visa's return on capital and cash return on invested capital substantially lower.

I dug out the annual report for both in 2017 and calculated the figures directly. I took Mastercard's operating income from its statement of operations, getting 6622 / 12536 (total assets - current liabilities) and got 52.9% ROCE. I got a 53% operating margin. Both figures are very close to the Sharepad data (you can always get a slight difference due to methods of calculation).

For Visa, I got 20.9% ROCE and 66.1% operating margin. Again, very close to the Sharepad data.

I think what may be depressing Visa's return on capital employed is the Europe acquisition, which influences its intangible assets. It increases them greatly and also the total assets, which then means we have more capital employed after subtracting the current liabilities. If we strip this out then the ROCE pretty much doubles to 40.3%, much closer to Mastercard's 52.9%.

Visa's operating margin is better, but both have extraordinary margins; Mastercard's return on capital employed is better, but both are strong; the final issue for me is the cash return on invested capital. Perhaps some accounting issue is influencing this but Mastercard looks to be getting a far better return in cash on the capital it is investing.

Visa is bigger than Mastercard and certainly has a better operating margin. Does that give it a better moat, as it has a larger more entrenched network?

Thoughts?

Best wishes

Mark.

[Lootman]

Historically it hasn't mattered too much which one of the two you choose. They both have near-identical business models and both have done very well, especially when you consider that the entire finance sector has been rubbish for over a decade. And they are very well covered by the Street so you or I don't have any kind of edge for choosing one over the other. Everything you cite is priced in.

The more important thing is to be in the payments space as I love this business. In the same way that oil pipeline companies are not exposed to oil price volatility, they charge a toll on all payments passing through and are not exposed to the risks that most banks and other finance companies are. They are not risking capital and as long as card use and online retail trade grows, they will do well. In fact the only Finance shares I hold are JP Morgan (the strongest bank on the planet that is not owned by a government), Berkshire Hathaway (technically in the Finance sector but really a conglomerate) and Visa.

I chose Visa as it has a higher profile in the US. I would not touch PayPal, nor American Express. In the UK, the Finance sector is a no-touch zone for me, along with retail, support services and utilities.

[ADrunkenMarcus]

Thanks Lootman.

I may be contrarian and go for Mastercard! It looks like the differences in returns are in large part an accounting issue rather than a fundamental difference.

I would not touch PayPal, nor American Express. In the UK, the Finance sector is a no-touch zone for me, along with retail, support services and utilities.

Why don't you like Paypal or American Express?

Best wishes

Mark.

[YeeWo]

Why don't you like Paypal or American Express?

I must say the whole conversation about this sector does make me think of threat of substitution/disintermediation by tech. VI/MC are bank operated franchise operations so a high ROCE is easy as all the franchisees do all the heavy lifting in a capital sense. AX is a closed-loop and does own the whole process globally, hence AX can provide enhanced data to MNCs and generally has an edge on T&E account management. Tech companies are destroying the barriers entry in this whole sector. All IMHO of course. Disc. From 1993 to 2002 I was an Amex Employee (really great company to work for at the time........).

[ADrunkenMarcus]

Why don't you like Paypal or American Express?

I must say the whole conversation about this sector does make me think of threat of substitution/disintermediation by tech. VI/MC are bank operated franchise operations so a high ROCE is easy as all the franchisees do all the heavy lifting in a capital sense. AX is a closed-loop and does own the whole process globally, hence AX can provide enhanced data to MNCs and generally has an edge on T&E account management. Tech companies are destroying the barriers entry in this whole sector. All IMHO of course. Disc. From 1993 to 2002 I was an Amex Employee (really great company to work for at the time........).

Wouldn't it be the case that Paypal, itself, is the disruptor?

Best wishes

Mark.

[paulnumbers]

Historically it hasn't mattered too much which one of the two you choose. They both have near-identical business models and both have done very well, especially when you consider that the entire finance sector has been rubbish for over a decade. And they are very well covered by the Street so you or I don't have any kind of edge for choosing one over the other. Everything you cite is priced in.

The more important thing is to be in the payments space as I love this business. In the same way that oil pipeline companies are not exposed to oil price volatility, they charge a toll on all payments passing through and are not exposed to the risks that most banks and other finance companies are. They are not risking capital and as long as card use and online retail trade grows, they will do well. In fact the only Finance shares I hold are JP Morgan (the strongest bank on the planet that is not owned by a government), Berkshire Hathaway (technically in the Finance sector but really a conglomerate) and Visa.

I chose Visa as it has a higher profile in the US. I would not touch PayPal, nor American Express. In the UK, the Finance sector is a no-touch zone for me, along with retail, support services and utilities.

I'm interested to hear why you call JP Morgan the strongest bank on the planet? Not a trick question!

[Lootman]

I'm interested to hear why you call JP Morgan the strongest bank on the planet? Not a trick question!

JPM was probably the only major bank to come out of the financial crisis with its reputation enhanced. It absorbed both Bear Stearns and Washington Mutual when both failed. That said, some think TD Bank of Canada is stronger:

https://seekingalpha.com/article/415981 ... -buy-today

[ADrunkenMarcus]

The benefits I see with Visa or Mastercard is they do not have credit risk. If people default on their credit card payments, then it's the bank's problem. If we get inflation, they're protected as they take a cut of higher retail prices.

Best wishes

Mark.

[dspp]

Historically it hasn't mattered too much which one of the two you choose. They both have near-identical business models and both have done very well, especially when you consider that the entire finance sector has been rubbish for over a decade. And they are very well covered by the Street so you or I don't have any kind of edge for choosing one over the other. Everything you cite is priced in.

The more important thing is to be in the payments space as I love this business. In the same way that oil pipeline companies are not exposed to oil price volatility, they charge a toll on all payments passing through and are not exposed to the risks that most banks and other finance companies are. They are not risking capital and as long as card use and online retail trade grows, they will do well. In fact the only Finance shares I hold are JP Morgan (the strongest bank on the planet that is not owned by a government), Berkshire Hathaway (technically in the Finance sector but really a conglomerate) and Visa.

I chose Visa as it has a higher profile in the US. I would not touch PayPal, nor American Express. In the UK, the Finance sector is a no-touch zone for me, along with retail, support services and utilities.

Tolling businesses have their own risks. The main risk is that somebody builds another competing parallel turnpike. Alternatively you get hijack risk at either end (hence gas pipeline operators generally trying to have a piece of the business both in the supplying gas field, and in the downstream retail). Occasionally there is a disruptive technology change and somebody builds a bypassing canal, or worse still a railroad. Oh, and there is anti-trust risk.

Right now there is a lot of disruption in technology, and there is anti-trust risk. Given this, what makes it likely that the past returns will continue ? If not, then these are overpriced imho.

Regards, dspp

[Lootman]

Tolling businesses have their own risks. The main risk is that somebody builds another competing parallel turnpike. Alternatively you get hijack risk at either end (hence gas pipeline operators generally trying to have a piece of the business both in the supplying gas field, and in the downstream retail). Occasionally there is a disruptive technology change and somebody builds a bypassing canal, or worse still a railroad. Oh, and there is anti-trust risk.

Right now there is a lot of disruption in technology, and there is anti-trust risk. Given this, what makes it likely that the past returns will continue ? If not, then these are overpriced imho.

Yes, good points. The inability to resist scope creep by toll collectors is a valid concern, and is why I don't like American Express (AP) so much. It's also a card issuer, does travel and insurance, and behaves more like a financial supermarket. I prefer a narrow focus which is what you get with Visa and MC.

V/MC has a comfortable duopoly and you are correct that a disruptive technology could challenge them. But just like it is very hard to build a railway or canal at this point, securing the market penetration of V and MC is a big task. The obvious disintermediators are PayPal and the whole Blockchain/Crypto thing, but I can't invest in those because I don't understand them (does anyone?). And there is always regulatory risk for such emergent enterprises.

V and MC are expensive - about 23 times earnings or so. But if you have to be in the finance sector, what else would you buy and feel as safe?

[ADrunkenMarcus]

V/MC has a comfortable duopoly and you are correct that a disruptive technology could challenge them. But just like it is very hard to build a railway or canal at this point, securing the market penetration of V and MC is a big task...
V and MC are expensive - about 23 times earnings or so. But if you have to be in the finance sector, what else would you buy and feel as safe?

I'm not sure it could even be done? Any competitor cannot replicate their decades old, entrenched networks overnight. And any such attempt would require very substantial capital investment upfront. Such investment could be met by the resources of Visa and Mastercard. How would a new competitor sell their services to a bank? HSBC switched their credit card provider from Mastercard to Visa a few years back - how would they have been persuaded to switch to 'Joe's Credit Cards PLC'?

I agree they are 'expensive' in terms of a PE of 23. However, if we take account of the strong growth both exhibit then it's arguably the case that they are not. As you indicated earlier, they are well researched (or well covered) companies and so such should be priced in.

Best wishes

Mark.

[ADrunkenMarcus]

Visa is showing as a free cashflow yield of about 4%, which seems attractive given the company's growth prospects IMHO.

Best wishes

Mark.

[ADrunkenMarcus]

Current forecasts - Sharepad:

Turnover growth:
Mastercard 43.1% (by 2021)
Visa 35.7% (by 2021)

Dividend Growth
Mastercard 21.7% (by 2021)
Visa 60% (by 2021)

Free Cash Flow Yield
Mastercard 3.3% (2019); 4.4% (2021)
Visa 3.7% (2019); 4.5% (2021)

I think the forecasts for Mastercard's dividend growth are dodgy. The 2019 dividend is already above the forecast.

Best wishes

Mark.

[ADrunkenMarcus]

I opted for MasterCard. Before current claims about court cases! But it'll be fine.

Best wishes

Mark.