Plastic will continue replacing cash as a payment method all over the world for years to come, and this is a strong secular tailwind benefiting the major players in the debit and credit card business.
The trend is particularly promising in emerging markets, where economic growth is faster and market penetration is lower than in developed countries. No company is better positioned than MasterCard (NYSE: MA ) to capitalize on this opportunity.
Different business models
There are basically two kinds of card companies with significantly different business models. Players like American Express (NYSE: AXP ) and Discover Financial (NYSE: DFS ) are involved in the lending business, while companies like Visa (NYSE: V ) and MasterCard are simply dedicated to processing transactions: All of the credit risk in their credit cards lies with the issuing banks.
American Express and Discover get a double boost when the economy is doing well since they benefit from growing consumption and expanding credit demand at the same time. Consumers have come a long way in terms of improving their financial position over the last years, and both companies are showing encouraging trends in terms of credit performance, so they are well positioned to benefit from growing credit demand in the middle term.
American Express reported a net lending write-off rate of 2% in the second quarter of 2013, relatively stable versus 1.9% in the first quarter of the year and 2.2% in the second quarter of 2012. Discover is doing well on the credit front, too: Loan delinquencies over 30 days past due reached a record low of 1.58% in the last quarter, and the credit card net charge-off rate decreased 2 basis points sequentially to 2.34%.
American Express and Discover appear to have their credit risk under control now, but both companies suffered serious losses during the 2008-09 financial crisis because of rising defaults in their portfolios. Credit exposure is always a considerable risk to watch when investing in these kinds of companies.
MasterCard and Visa, on the other hand, offer much more visibility regarding potential risks, and their business models allow for faster international expansion because they don't need to worry about their customers' creditworthiness too much.
Nielson Report estimates that cards accounted for a 48% percent of total U.S. consumer purchases in 2010, a number expected to grow to 59% in 2015. But things are very different on a global scale: A whopping 85% of global transactions are still done in cash, and that represents a huge opportunity for MasterCard.
Visa is bigger than MasterCard, but when it comes to growth opportunities in emerging markets, MasterCard is outgrowing its competitor.
MasterCard generated over $1 trillion in gross dollar volume during the last quarter, and almost 70% of that volume came from international markets. Key regions like APMEA -- Asia Pacific Middle East and Africa -- and Latin America were particularly strong with annual growth rates of 18.8% and 17.5%, respectively.
Visa had $1.7 trillion in total volume during the quarter, although regions like Asia Pacific and Latin America are still doing well, with growth rates in the area of 10.5% and 9.9%, respectively, Visa is clearly lagging MasterCard in those regions.
Companies in this business benefit from the network effect: Merchants need to accept cards that bring in customers, and customers prefer to use cards that are widely accepted among merchants. The service becomes more valuable as it gains more users, and more users increase the value of the service, creating a self-sustaining cycle of growth and increased competitive strength that can be a powerful growth driver over the long term.
Brand recognition is a key asset in the payments industry, in which trust and reliability are very important attributes. The MasterCard brand is globally acknowledged thanks to marketing initiatives like the memorable "Priceless" campaign, so consumers around the world know they can purchase almost anything, anywhere, with a MasterCard card.
MasterCard is building an enormously valuable network with strong brand recognition in emerging countries, and that means the company is exceptionally well positioned for growth over the coming years.
Cash still accounts for a huge proportion of retail transactions around the world, especially in emerging markets. Economic growth and access to all kinds of financial services will inexorably expand the plastic revolution to those countries over time, and MasterCard is in a rock-solid position to benefit from that opportunity.