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Visa and MasterCard: Don’t Chase Them Higher

Credit card giants MasterCard (NYSE:$MA) and Visa (NYSE:$V) both crushed earnings estimates this past week, and both are sitting near new all-time highs.

Not bad, considering the line of work they are in.  Given that the global economy has been tepid at best lately and that unemployment remains stubbornly high, you might not expect companies that depend on consumers opening their wallets to perform well.

But by focuses narrowly on the consumer angle, you miss the proverbial forest for the trees. MasterCard and Visa—along with American Express (NYSE: $AXP) and, to a lesser extent, Discover (NYSE:$DFS)—are some of the prime beneficiaries of two of the most powerful macro trends of the past 20 years:

  1. The   transition to a global cashless society
  2. The rise of the emerging market consumer

The first point should be obvious.  Even in the United States, where credit and debit cards are ubiquitous, roughly 40% of all transactions are conducted with cash or paper checks.  Not all transactions will ever be captured with credit and debit cards, of course, but with internet commerce growing relative to “bricks and mortar,” you can bet that the percentage will grow.

Demographics also play a role here.  Older consumers who might never have embraced plastic are a shrinking segment of the population, whereas anyone under the age of 50 grew up with credit cards and anyone under 30 learned how to swipe a credit card before they could walk.

I exaggerate…but not all that much.

Card usage is also working its way down the economic ladder.  Consumers without access to traditional credit or banking services are embracing prepaid cards branded with the Visa and MasterCard logos, and both companies are experimenting with ways to let consumers pay at retail cash registers using their mobile phones. Even American Express, which has traditionally focused on a more patrician business clientele, has partnered with Wal-Mart (NYSE:$WMT) in promoting its Bluebird prepaid cards (see “Is Amex Going Slumming?”).

This is a long way of saying that even if overall consumer spending growth is tepid, growth in electronic payments has plenty of room to grow.

The second point is the one I find the most promising, however.  Credit and debit card usage is soaring in virtually all major emerging markets as incomes rise and consumers join the ranks of the global middle class.  Rising incomes and growing financial sophistication can only mean a higher percentage of transactions move from cash to plastic. Both Visa and MasterCard stand to benefit from this trend, though Visa has the better presence globally.  Visa expects to get more than half of its revenues from overseas by 2015, and the overwhelming amount of this will come from emerging markets.

So what’s the downside?

As I see it, there are two.  The first is competition from other mobile payment solutions such as eBay’s (Nasdaq:$EBAY) Paypal and Square.

It gets a little muddy here, however.  Paypal is a payment mechanism in of itself, but it is also a facilitator for payment with a traditional credit card. Up until this point, the mobile revolution has been nothing but beneficial for the traditional credit card companies. The card readers for Square and Paypal Here turn any Apple (Nasdaq:$AAPL) iPhone or Google (Nasdaq:$GOOG) Android device into a mobile point-of-sale terminal.  Even an ice cream man or hot dog street vendor can take payment by card now.

But this is also a fast-changing area, and there is a possibility that Visa and MasterCard can see themselves getting pushed out as unnecessary middlemen.  On my recent visit to Home Depot (NYSE:$HD), the cash registers gave me the option to pay with Paypal. Today, this is a novelty.  But in five years, will it be the norm?

Maybe, maybe not.  But given the rate of change in this space, I am reluctant to pay too high a premium for the stocks in this sector.  The growth is impressive and the profit margins are so high as to be absurd.  But as with any investment, you don’t want to overpay.

And this brings me to the second downside.  Both MasterCard and Visa sport valuations that are reminiscent of the 1990s tech bubble.  Visa trades for an absurd 50 times trailing earnings and 21 times expected 2014 earnings.  MasterCard, at 25 times trailing earnings and 18 times forward earnings, almost looks reasonable by comparison.  Almost.

As much as I like both companies, I’m not comfortable paying these prices.  For now, I’d recommend you pass on Visa and MasterCard.

In the card sphere, American Express would appear to be the best bargain.  Unlike Visa and MasterCard, Amex actually accepts credit risk, but I am ok with that.  In an improving economy, that is not such a bad thing. Amex trades for 13 times expected earnings and pays a 1.2% dividend.

Disclosures: Sizemore Capital is long WMT.

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Visa: A Gold-Medal Opportunity

As I write this article, China has a slight lead on the United States in Olympic gold, 34-30, but anything can happen over the next week.

But whichever country leaves London with the bigger stash of medals, Visa (NYSE:$V) will be accepted in either of them.

In fact, Visa is accepted in virtually every country represented in the 2012 Summer Games.

Visa has a long history with the Olympics. The company is a major sponsor this year, just as it has been for 26 years now. It makes sense; a company with one of the most global brands in history making itself seen as a patron of the ultimate global sporting event.

It is Visa’s global reach that makes it one of the most attractive growth stocks for the next decade. As I noted in a recent article, Visa benefits from two overlapping macro trends.

First, irrespective of what happens in the U.S. economy or how the eurozone crisis unfolds, incomes are rising in emerging markets. Visa is projected to get more than half of its revenues from outside the United States by 2015, and most of this will come from emerging-market card-swiping.

The second theme is the continued growth of electronic payments at the expense of cash and checks; call it the “death of cash.” This is a trend that still is playing out in the United States, where roughly 40% of all transactions still are done with cash or check, but the transformation is more obvious in emerging markets. When I visit my wife’s family in South America, we still have to remember to carry cash. I don’t think this will be true in another five years.

Card acceptance is a virtuous cycle; the more consumers request to pay with plastic, the more retailers feel obligated to oblige. At the same time, the more retailers who accept plastic, the more convenient it becomes for consumers to leave their cash at home.

Plus, it’s safer to pay with plastic. The occasional story of a data breach, cardholders have very little risk of theft, as they are not liable for fraudulent purchases. Alas, there is no one to reimburse you if a thief steals a roll of cash.

And given that you are reading this article online, we should not forget the role that Internet commerce plays. Though still small when compared to the broader brick-and-mortar retail economy, e-commerce is becoming a larger piece of the pie every year. Traditional credit and debit card companies benefit from this, as do relatively new upstarts like eBay’s (NASDAQ:$EBAY) PayPal.

So, there you have it — more shopping by emerging-market consumers and a higher percentage of existing shopping switching to plastic. An investment thesis in fewer than 20 words.

Right now, Visa and rival MasterCard (NYSE:$MA) are a little pricey at 18 and 16 times forward earnings, respectively. So you might want to wait for a dip before buying. But if I had to choose one stock to hold for the next 10 years, Visa would be near the top of my list — even at current prices.

Disclosures: Sizemore Capital is long Visa.  This article first appeared on InvestorPlace.

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Visa and MasterCard: Underlying Macro Trends Still in Place

“Gimme what I need, uh, MasterCard or Vi-suh.”

From Wyclef Jean’s “Perfect Gentleman”

The U.S. consumer is in a bit of a pickle.  Jobs are not particularly easy to come by—the June jobs report showed unemployment sticking at 8.2% and only 80,000 new jobs created for the month—and the economy remains sluggish. 

True, the average American family carries less debt than they did a few year years ago, but their net worth hasn’t exactly grown much either. 

In short, the prognosis for the consumer is bleak. 

Retail stocks have held up relatively well, all things considered, though higher-end luxury retail has taken a beating.  Long-time Sizemore Investment Letter recommendation Coach ($COH) is down nearly 30% from its 2012 highs, and competitor Michael Kors ($KORS) is down by over 16%.  Investors fret that a slowing economy—and in particular slowing Chinese and emerging market economies—will lead to a disappointing string of quarters for purveyors of expensive discretionary purchases.

Yet amidst the bearishness towards bling, Visa ($V) and MasterCard ($MA) have been notable bright spots.  Visa is just 1-2 good trading days away from a new all-time high, and MasterCard is not far behind. 

There are a lot of high expectations built into the stock prices of both credit card companies.  Visa sells for 19 times trailing earnings and MasterCard for a lofty 27 times trailing earnings.  Forward estimates put the ratios at a more reasonable 17 and 16 times earnings, respectively, though both are well above the average for the S&P 500.

The optimism is not unwarranted.  Both companies are debt free. Visa enjoys mouth-watering operating and profit margins of 60% and 42%, respectively, and MasterCard’s profitability is only a hair’s breadth lower.   Both also enjoy returns on equity that would be the envy of any company outside of the technology sector.  In short, both companies deserve to trade at a premium to the broader market.

Still, with so much optimism baked into the stock price, a slight earnings miss by either could send shares tumbling in the short-term.  This is always the risk you run when buying a “hot” stock, and I would be wary of it as we enter earnings season.

Any sustained weakness should be viewed as a fantastic buying opportunity.  When I made Visa my pick in InvestorPlace’s 2011 “10 for 2011”stockpicking contest, I noted two durable macro trends that are still very much in place:

  1. The   transition to a global cashless society
  2. The rise of the emerging market consumer

The first point should be obvious.  Even in the United States, where credit and debit cards are ubiquitous, roughly 40% of all transactions are conducted with cash or paper checks.  Not all transactions will ever be captured with credit and debit cards, of course, but with internet commerce growing relative to “bricks and mortar,” you can bet that the percentage will grow. 

Consumers without access to traditional credit or banking services are embracing prepaid cards, branded with the Visa and MasterCard logos, and both companies are experimenting with ways to let consumers pay at retail cash registers using their mobile phones. 

This is a long way of saying that even if overall consumer spending growth is tepid, growth in electronic payments has plenty of room to grow.

The second point is the one I find the most promising, however.  Credit and debit card usage is soaring in virtually all major emerging markets as incomes rise and consumers join the ranks of the global middle class.  Both Visa and MasterCard stand to benefit from this trend, though Visa has the better presence globally.  Visa expects to get more than half of its revenues from overseas by 2015, and the overwhelming amount of this will come from emerging markets. 

Visa is what I call a classic “emerging markets lite” investment.  You get all the benefits of emerging markets growth but without the volatility and headache of investing in emerging markets directly.

Both Visa and MasterCard are due to report earnings within the next month.  I will be curious to see how the management of each addresses the effects of the economic slowdown in China and the rest of the developing world.

I suspect that, once the numbers are sorted, it will be clear that Chinese imports of iron ore and copper are in a protracted decline, but Chinese credit and debit card swiping are healthier than ever. 

In the meantime, I reiterate my recommendation to buy shares of both companies on any protracted weakness.

Disclosures: Sizemore Capital holds shares of Visa and Coach.

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Visa, MasterCard Still Charging Forward

Credit card rivals MasterCard (NYSE:$MA) and Visa (NYSE:$V) released earnings on Wednesday, and both knocked the ball out of the park.

We’ll start with MasterCard.  This smaller of the two rivals enjoyed earnings growth of 25% in the first quarter and a 17% increase in worldwide purchase volumes.  Not to be outdone, Visa announced a 30% rise in earnings per share on an 11% rise in payments volume.

I admit, I’m a little partial to Visa.  The stock was my pick last year in InvestorPlace’s “10 Stocks for 2011” contest, and it crushed the competition.  (Alas, Turkcell (NYSE:$TKC), my pick for 2012, is off to a slower start—for now).

But as great as Visa’s performance has been over the past year and a half, MasterCard has been the better stock.

As a smaller, nimbler company, MasterCard’s growth has been more impressive than Visa’s in recent years, and MasterCard suffered less fallout from the Dodd-Frank Durbin Amendment fiasco that sought to limit the fees charged to merchants for debit cards.  Yet I contend that Visa remains the better long-term buy for reasons I’ll address shortly.  First, I’ll throw a bone to MasterCard bulls.

One of the provisions of the Durbin Amendment allowed merchants to choose the network that they used to process debit card transactions.  As the bigger of the two networks, Visa had far more to lose than MasterCard, and MasterCard has profiting handsomely at Visa’s expense.  Visa’s debit volume grew by only 2% for the quarter, while MasterCard’s grew by over 20%.  MasterCard will likely continue to nip at Visa’s heels for the foreseeable future in the U.S. debit market, which is the single most important segment of Visa’s business.

MasterCard and Visa have both benefitted from improving consumer sentiment in the United States and, outside of Europe, a healthier global economy.  But even if consumer spending growth is tepid in the years ahead, there is every reason to believe that both MasterCard and Visa can continue to see spectacular growth in purchase volumes (both credit and debit).

The world is going cashless.  Perhaps nothing illustrates this more than the various new iPhone credit-card-swiping apps.  Yes, next time you borrow $20 from your buddy, you can pay him back using nothing more than a credit or debit card and an iPhone.  Gotta love it.

Yet despite the seeming ubiquity of credit and debit cards, roughly 40% of all transactions are still carried out by cash and paper checks in the United States.  Remember, the United States is the most heavily penetrated of all major markets, so the percentage is much lower virtually everywhere else in the world.

This brings me to my primary reason for favoring Visa over MasterCard—Visa is far better positioned to profit from the rise of the emerging market consumer.

Visa already gets nearly half of its revenues from overseas, and most of this is from emerging markets. As incomes rise in the developing world, consumers have far more discretionary income than they used to, and they are spending a greater percentage of that with a swipe of plastic .

Alas, I would be remiss if I didn’t mention one big negative for Visa.  During the earnings release conference call, Visa announced that the U.S. Department of Justice was investigating the company for potential anti-trust violations related to debit card processing.  It’s too early to say how serious the investigation is or what Visa’s potential liability is, but the news sent the share price down sharply after hours.

At this stage, I do not see the investigation having a significant impact on Visa’s business, and I recommend using any weakness in the share price as an opportunity to accumulate more shares.

Disclosures: Visa is held by Sizemore Capital clients.

 

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Warren Buffett Buying the Sizemore Investment Letter’s Picks

Lest I be accused of hero worship, I’ll spare readers another Warren Buffett lovefest article.  Yes, Buffett is a living legend, and yes, he is arguably the best investor of all time.  But these facts are nothing new, and there have already been more articles than I can count written about the man and his methods over the years.  Buffett has been elevated to something akin to a demigod in the minds of many value investors, and the art of investing like Buffett is a subject that has been thoroughly beaten to death by the financial press.

With all of this as a caveat, I’ll let readers in on a little secret:  I do like to keep tabs on what Buffett is buying or selling.

It is never a good idea to blindly ape the trades of another investor—even one with a track record like Buffett’s.  Due to the time lag in reporting with the SEC, an investor you follow may very well have sold the position you are copying by the time you buy it.  And what makes sense in that investor’s portfolio might make no sense at all in yours.

Still, given Buffett’s penchant for long investment time horizons, he’s a little easier to follow than most.  And, again, his track record over the years make him a man worth watching.

Imagine my pleasure this afternoon when I saw Berkshire Hathaway’s updated portfolio holdings for the third quarter of 2011 (see Warren Buffett’s portfolio).  Three out of Buffett’s five new additions were Sizemore Investment Letter recommendations.

Buffett initiated positions in SIL recommendations DirecTV ($DTV), Intel ($INTC), and Visa ($V).  His other two additions were pharmacy chain CVS ($CVS) and defense contractor General Dynamics ($GD).

While I was not invited to Buffett and partner Charlie Munger’s strategy sessions before these purchases were made (I’m sure my invitation was lost in the mail), I have a pretty good idea of what Buffett sees in DirecTV, Intel, and Visa.  Each is a leader in its respective industry, and all three benefit from durable, long-term macro trends.

Let’s start with DirecTV, the world’s largest provider of paid satellite television.  Given that TV-over-internet options like Netflix ($NFLX) and Hulu are increasingly crowding the turf of traditional paid TV—and given that the paid TV market in the United States is already saturated—Buffett’s choice here might raise a few eyebrows.

I can assume that Mr. Buffett’s rationale was the same as my own:  DirecTV is a direct play on rising living standards in the fast-growing markets of Latin America, where it already has 11.1 million subscribers (vs. 19.8 million in the United States).  Latin American revenues were up 46 percent in the 3rd quarter, due primarily to subscriber growth.  But even in the United States—where everyone already has paid TV service in one form or another—revenues were up 8 percent.  Not bad, given the precarious financial situation of the average American.  DirecTV is also very reasonably priced at just 10 times expected earnings.

Moving on to Intel, my only question to Buffett is “What took you so long?”

Intel absolutely dominates the market for computer processor chips.  But this very strength is what has caused investors to shun Intel.  You see, the PC is dead.  Smart phones and the iPad killed it.  And given that Intel is still quite weak in the mobile market, the company is resigned to be a slow-growth behemoth.  Who wants to own a dinosaur like Intel?

That story would seem to make sense at first.  The problem is that it’s simply not true.

The PC is far from dead.  Smart phones and tablet computers are growing at a much faster rate, of course.  And the PC market does depend more heavily on the corporate and enterprise market, which is not in the best of shape in this economy.  But tablets and smart phones do not replace a computer for most users.  And in most emerging markets, PCs are still very much a growth industry.

Intel’s revenues and earnings are growing at 28 percent and 17 percent year over year, respectively.  And that is in near recessionary conditions.  Meanwhile, the stock trades at just 9 times expected earnings and yields 3.4 percent.  At current prices, I consider Intel a safer investment than most AAA-rated bonds.

Finally, we come to Visa.  Visa and rival MasterCard ($MA)—also a Berkshire holding—have become somewhat trendy of late, but it wasn’t like that for most of the year.  Regulatory uncertainty cast a pall over credit card stocks, as did fears of a consumer slowdown.  Yet investors who were, in Buffett’s words, greedy when others were fearful did quite well in Visa and MasterCard.  Both are among the best-performing stocks of 2011.

Visa and MasterCard benefit from two powerful macro trends—the transition to a global cashless society and the rise of the emerging-market middle class.  As electronic payments become a larger share of commerce, credit and debit cards—as well as newer payment methods such as PayPal—will increasingly replace cash and checks.  And while this process is well on its way in the United States and other developed markets, it is only just beginning in most emerging markets.  This is a trend that will be with us for a while.

Visa trades for 14 times expected earnings, which is a bargain for a company with Visa’s brand, financial strength and growth prospects.

DirecTV, Intel, and Visa are all long-term holdings of the Sizemore Investment Letter.  And while Buffett’s reasons for purchasing may have been very different from our own, we’re glad to see the Sage of Omaha sharing our enthusiasm.

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