MasterCard Fixed at Neutral

We have reiterated our Neutral recommendation on MasterCard Inc. (MA - Analyst Report) based on its steady growth profile amid the volatile economic and regulatory environment. The company reported operating earnings of $6.17 per share in the third quarter of 2012, which noticeably outpaced the Zacks Consensus Estimate of $5.93 per share and the year-ago quarter’s earnings of $5.63 a share.

The better-than-expected results were largely due to the outcome of better pricing, increased number of processed transactions, strong GDV growth and lower tax rate. However, higher-than-expected operating expenses partially limited the margins’ upside.

Over the past few years, MasterCard has been diversifying its product portfolio through innovations that include e-commerce, mobile payments (m-commerce), prepaid cards, smart cards and other value-added services in order to realign it to capitalize on the most promising growth opportunities, even in the emerging economies. A strong and diverse product portfolio also helps the company mitigate the challenges from the recent regulations and economic volatility across the globe. Management’s guidance of generating double-digit top-line growth of about 12–14% in the next couple of years also reflects a sustained growth momentum and bodes well for the ratings of the company.

We further believe that MasterCard’s strategy to achieve long-term growth through global acquisitions, alliances and its array of user-friendly and flexible products are also crucial for sustaining the competitive pressure and generating optimism over management’s expectation of delivering earnings growth of over 20% in the next 2–3 years. Additionally, the company enjoys a strong cash and available-for-sale investment position along with strong operating cash flow, retained earnings and no long-term debt for over a couple of years now.

However, MasterCard continues to face headwinds in maintaining the cost of operations of its vastly expanded business. While operating costs continue to showcase an increasing trend, higher expenses on litigation settlements and other regulatory challenges not only weigh on the financials but also impose restrictions on the scope of business growth. Management’s attempt to maintain at least 50% in operating margins over the next couple years also reflects the impact of these headwinds.

Moreover, intense competitive pressure from arch rivals such as Visa Inc. (V - Analyst Report) and American Express Co. (AXP - Analyst Report),in the midst of the ongoing weak global cues is likely to add to the woes. Further, the sluggish and volatile credit quality of the market, amid the recent global crisis, has adversely affected MasterCard’s credit and charge card growth, besides disturbing the pricing, credit allocation and business model of the company.

The currency and interest rate fluctuations along with the higher rebates and incentives passed on to the customers and intermediaries will continue to weigh on the margins of the company. Subsequently, difficult comps, timing of the deal renewals and the economic volatility has led management to peg top-line growth below 13% for the second half of 2012.

Hence, based on the pros and cons, the Zacks Consensus Estimate pegs earnings for the fourth quarter of 2012 at $4.78 per share, which is about 19% higher than the year-ago quarter. For 2012, earnings are expected to climb about 17.5% over 2011 to $21.96 per share.

MasterCard currently retains a Zacks #3 Rank, which translates into a short-term Hold rating and indicates no clear directional pressure on the stock in the near term.