An unusual feature of this recession compared to past downturns is that the banking crisis preceded the main slump. Usually banks are hit later in the cycle, once unemployment has risen and borrowers fail to repay their debts. The big concern for credit-card franchisers like Mastercard, the world’s second-largest card brand (behind Visa), is that this second wave of loan defaults is only just beginning. Worryingly, this will be exacerbated because millions of families are withdrawing cash on plastic to settle mortgage and household bills. This will end in tears, yet it is only just showing up in the economic data.
Turkey of the week: Mastercard (NYSE:MA), rated OUTPERFORM by Macquarie
For example, at Mastercard’s October results, the firm beat Wall Street earnings forecasts by 10%, driven by continued strength in emerging markets and the shift from cash to electronic transactions. What’s also delaying the blood-bath is that Mastercard acts as the middle-man, licensing its brands and taking a cut of gross sales value. It doesn’t extend credit to consumers, so doesn’t directly bear the risk of default. But don’t be fooled, the danger is growing by the day.
Consumers are cutting back on travel and spending less in hotels, which will hit Mastercard’s income. And last week there was some grim news from JP Morgan saying that consumer spending fell a dramatic 8% in the fourth quarter of 2008, while Bank of America (–17%) and Citigroup (–15%) both reported big falls in credit-card volumes. It’s only a matter of time before the front-line card issuers say enough is enough and slash credit limits to protect their balance sheets, again knocking the group’s royalties.
Another problem is that a new law is being introduced in July 2010 to stop US credit-card providers hiking interest rates on outstanding balances and penalising borrowers for late payments. This will cause some banks to lend less. Finally, Mastercard’s rating compared to the rest of the finance industry looks way out of line. Analysts expect 2008 revenues and underlying earnings per share of $5.0bn and $8.94 respectively, rising to $5.3bn and $10.03 in 2009 – putting the shares on racy earnings multiples of 15 and 13.4. The projected 12% jump in EPS this year looks a huge stretch, given that all Western economies are officially in recession and credit-card defaults are only just starting. In my opinion, there is a fair chance the board will issue a profits warning when it reports its full-year results on 5 February.
Recommendation: SELL at $134
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.