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MasterCard Posts Balanced 2Q

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MasterCard Inc.’s (MA - Free Report) second-quarter 2012 operating earnings per share of $5.65 modestly surpassed the Zacks Consensus Estimate of $5.56. This also outpaced the year-ago quarter’s earnings of $4.76 per share.

Operating net income for the reported quarter stood at $713 million, spiking 17.2% from $608 million in the prior-year quarter. Including the after-tax provision for litigation expense of $13 million or 10 cents a share, reported net income stood at $700 million or $5.55 per share. No such special items were recorded in the year-ago quarter.

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

Total revenue climbed 9.2% year over year to $1.82 billion, although it lagged behind the Zacks Consensus Estimate of $1.88 billion. On a constant currency basis, net revenue increased 13.0%. The upside was primarily due to a 29.0% jump in the number of processed transactions to 8.5 billion along with a 17.0% increase in cross-border volumes.

During the reported quarter, GDV increased 15.0% to $890 billion, while worldwide purchase volume rose 13.0% year over year, on a constant currency basis, to $661 billion. As of June 30, 2012, MasterCard issued 1.8 billion MasterCard and Maestro-branded cards.

Total operating expenses increased 5.6% year over year to $826 million. This excludes the pre-tax litigation provision of $20 million, including which operating expenses increased 8.2% during the reported quarter. On a constant currency basis, operating expenses increased 9% year-over-year.

The overall increase primarily resulted from a 14.3% year-over-year upsurge in depreciation and amortization expenses along with a 9.4% increase in general and administrative expenses. However, advertising and marketing expenses dipped 7.2% year over year to $179 million.

Consequently, excluding litigation provision expense, operating income grew 12.3% year over year to $994 million in the reported quarter. Moreover, operating margin expanded to 54.6% from 53.1% in the year-ago quarter, while including the litigation provision expense, operating margin was recorded at 53.5%.

MasterCard's effective tax rate for the reported quarter was 28.0%, quite lower than 31.8% in the year-ago period, primarily attributable to a favourable geographic mix of earnings and additional export incentives.

Financial Update

As of June 30, 2012, MasterCard’s net operating cash flow grew 19.6% year over year to $1.07 billion. At the end of the reported quarter, cash and cash equivalents slightly reduced to $3.15 billion from $3.73 billion at 2011-end, while the long term-debt remained nil.

Meanwhile, retained earnings increased to $6.05 billion at the end of the reported quarter from $4.75 billion at the end of 2011. Total equity rose to $6.28 billion from $5.88 billion as of December 31, 2011.

Share Repurchase Update

On June 5, the board of MasterCard sanctioned a new $1.5 billion share repurchase program for its Class A common stock. This new share repurchase program will be effective only after the completion of the previous $2 billion share repurchase program, which was expanded from $1 billion in April 2011.

As of May 31, 2012, the company had approximately $270 million remaining under the current $2 billion share repurchase program authorization. During the reported quarter, MasterCard repurchased about 1.6 million shares for $671 million.

MasterCard has bought an additional 304,600 shares for approximately $57 million since the second quarter of 2012. To date, about $1.4 million in stock remains available under the latest $1.5 billion share repurchase program authorization.

Dividend Update

On June 5, 2012, the board of MasterCard announced a regular cash dividend of 30 cents, which will be paid on August 9, 2012, to shareholders of its Class A common stock and Class B common stock as on July 9, 2012.

On February 7, 2012, the board of MasterCard announced a 100% hike in its dividend to 30 cents per share from the prior level of 15 cents per share. The increased dividend was paid on May 9, 2012 to shareholders of its Class A common stock and Class B common stock as on April 9, 2012.

Peer Take

Last week, MasterCard’s prime peer, Visa Inc. (V - Free Report) , reported its fiscal third-quarter 2012 (ended June 30, 2012) operating earnings of $1.56 per Class A common share, outpacing the Zacks Consensus Estimate of $1.45 per share. Additionally, the earnings substantially exceeded prior-year quarter’s earnings of $1.26 per share.

However, on GAAP basis, Visa recorded a net loss of $1.84 billion or $2.74 per share against a net income of $1.01 billion or $1.43 per share in the year-ago quarter. The loss was primarily attributable to a litigation settlement payment of $4.1 billion or $4.30 per share, related to the recent multi-district litigation case.

Our Take

MasterCard benefits from strong secular demand growth, meaningful international exposure, diversified product portfolio, high barriers, excellent pricing power, risk-free balance sheet and impressive operating leverage. The recent strategic acquisitions and alliances also bode well for long-term growth.

Also, the above-average earnings growth, strong competitive position and leverage to an eventual economic recovery will result in a relative valuation premium.

However, we are concerned about MasterCard’s resilience and ability to raise prices, increased operating and litigation expenses, the detrimental effects of the Consumer Protection Act in the U.S. and scope for increasing cash flow. Based on these factors, MasterCard carries a Zacks Rank #3, which implies a near-term Hold rating, while our long-term recommendation remains Neutral.

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