Its shares may have dipped the day Mastercard Inc. (MA 0.01%) reported its third-quarter earnings last month, but long-term investors had no reason to fret. The company's earnings release reinforced the narrative that huge societal trends, such as the digitization of money, would provide Mastercard with a long runway for growth.
In the third quarter, revenue adjusted for foreign currency fluctuations rose to $3.9 billion, a 17% increase year over year, while adjusted earnings per share grew to $1.78, a 36% increase year over year. The top- and bottom-line growth was fueled by an increase in Mastercard's gross dollar volume (the amount of money that travels across its payment network), which rose to $1.47 trillion, a 13% increase over last year's third quarter. Mastercard also saw a 16% increase in switched transactions, the number of times a Mastercard-branded product was used to originate a transaction.
| Mastercard Metrics | 2018 Q3 | 2017 Q3 | Change (YOY) |
|---|---|---|---|
| Revenue | $3.90 billion | $3.40 billion | 17% |
| Adjusted EPS | $1.78 | $1.34 | 36% |
| Adjusted operating margin | 59.4% | 57.1% | 2.3 percentage points |
| Other revenues | $819 million | $747 million | 10% |
Data source: Mastercard Inc. YOY = year over year.
In Mastercard's conference call, one theme consistently stuck out: the massive return on investment the company is seeing from the services it is building out for its merchant and financial-institution partners. Let's look at this crucial element in Mastercard's success.
Mastercard is strengthening the relationship with its customers by offering them services such as fraud prevention tools, data analytics, and loyalty program management. Image source: Getty Images.
Mastercard's investment in services
One of the attractive characteristics of Mastercard's business model is that it supports a high operating margin. This margin shows the percentage of profit left over after accounting for most of the company's expenses, including the cost of goods or services sold, general and administrative costs, and research and development expenses. Mastercard's operating margin this quarter was 58.7%, a high level of profitability that companies in most industries simply cannot obtain. This gives Mastercard a lot of leeway to invest in opportunities to grow its core business or look for other opportunities to grow revenue.
In the conference call, CEO Ajay Banga said his goal was to keep the operating margin at 50% "to explain to our investors that we are committed to running the company with a fair degree of efficiency and profitability." Above that level, he explained, he would rather invest in opportunities to capture market share against cash or increase Mastercard's investment in its services. These services include fraud prevention tools, data analytics, and management of loyalty reward programs that it can upsell to its financial-institution and merchant clients.
This quarter, Mastercard launched a new service, AML Insights, a platform to fight money laundering that helps banks identify it early and ensure they comply with all money laundering laws and regulations. The platform is now live in the U.K. and being used by 10 banks in the country representing 90% of the banking market.
Why the strategy is working
During the conference call, Mastercard highlighted more deals where large companies subscribe to these services, both in the U.S. and abroad. Kroger, one of the country's largest grocery chains, now subscribes to what Mastercard called a "broad array" of products and solutions, including data and analytics, fraud tools, and digital services. Bankia, one of the largest banks in Spain, will switch its debit and credit card portfolios to Mastercard while also taking advantage of Mastercard's advisers and lab services to build out its technological services. And HSBC Holdings will use Mastercard's advisers and data analytics to "help optimize their portfolios."
With these new deals, it is little wonder that the revenue these services bring in is really beginning to add up. Accounted for under the Other Revenues category in Mastercard's quarterly presentation, this segment brought in $819 million, a 10% increase over last year's Q3 total.
The advantages of these services
When asked how Mastercard would fare during an economic downturn, Banga said its services help give the company more stability if consumer spending were to go down. "Remember, we now have another leg of the stool, which is our services, and there's pricing there as well," he said.
Yet the biggest advantage of being able to offer these types of tools to its clients might be the deeper and closer relationships Mastercard now enjoys. It is no longer offering just a commoditized product -- a payments network that moves money from the consumer's bank to the merchant's -- that certain other competitors can also offer. Instead, it has advanced features and services in which banks and merchants are finding value. These deeper relationships will make it much harder for clients to switch to a competitor when their current deals expire.
Banga said:
I'm hoping you guys are beginning to see a lot of those services embedded in our relationships with merchants, issuing banks, governments, and acquiring systems. And the embedding of those services in those relationships enables us to not only have a better, more holistic relationship with our partner, but it also enables us to be seen as a value-added partner, not just a price play. Price is important -- don't get me wrong, I've said this every time -- but it also allows you to have more than that, in addition to the service being a good revenue and good margin generator on its own.
Is Mastercard a smart buy right now?
Mastercard's shares are certainly not cheap. Based on the company's trailing 12 months of adjusted EPS, the stock price currently sports a P/E ratio of about 32.5, a decent premium over the S&P 500 average.
But as global consumers continue to wage war on cash, Mastercard seems to be well positioned to capitalize. With its growing number of services, Mastercard also might be beginning to differentiate itself from the competition while giving its revenue growth an extra boost. With its competitive advantage in a growing industry, Mastercard shares seem well worth the premium the market is giving them.
