Mastercard (NYSE: MA) is a high-quality company with a high multiple in the market.

Given the current market situation, this multiple does not appear to be justified by its growth prospects.

The market is not pricing in some risks to the company’s strong moat. We feel that investors should remain neutral on this name until a better opportunity to purchase shares arises.

Growth Prospects are Dim

Mastercard reported a 15% increase in sales and a 14% increase in net income in their most recently reported quarter. Given the macro situation, they are solid figures.

It’s difficult to envision Mastercard maintaining this kind of growth in the future, mostly because retailers are starting to fight back on interchange fees.

Mastercard’s inability to raise interchange rates removes a growth lever for the company.

They may also be obliged to reduce transaction costs, which would result in margin compression.

At the moment, Mastercard’s revenue and earnings are mostly determined by total nominal transaction value.

The company is strong, but it has captured all of the markets it can reach, and it cannot raise interchange rates any higher.

Mastercard is a solid and reliable company, but relying on spending growth carries significant dangers.

Long-Term Dangers

The market believes Mastercard has a strong moat, but some possible challenges are on the horizon.

Legislative scrutiny poses a significant danger to both Mastercard and Visa (V).

Legislative pressure intensifies as more retailers criticize the companies for the amount of each transaction they accept.

Regulators appear to detest the main card networks and will most certainly take more action against them during the next decade.

This should minimize the premium that the market charges card networks.

Crypto payment networks pose a danger to the big card networks because they want to totally bypass their payment system and, in many cases, established financial institutions.

I’ve never been a fan of cryptocurrency, but it is undoubtedly a threat to payment networks.

In recent years, buy now, pay later payment alternatives have grown in popularity.

People can use BNPL companies to spend money now and pay for it later in installments through their bank accounts.

This completely avoids the card networks.

While this notion has been tested before and does not appear to be a viable business model, any potential decrease in transaction volume due to a shift in cultural preferences poses a risk to Mastercard.

Margin compression is a big danger that could arise from a variety of sources.

Regulatory scrutiny and competitive pressures are the two most significant causes of potential margin compression.

If governments around the world start taking action against card networks, they may be pushed to cut their fee rates.

If businesses and consumers have a profusion of options, card networks may need to make themselves more appealing by lowering costs or increasing incentives.

This would very certainly result in margin compression in the long run.

Price Movement

Mastercard has done admirably over the last year and is now in the black.

Even though we do not consider Mastercard to be a “buy,” we consider the company to be a strong component of a balanced portfolio, and investors can feel comfortable owning the shares.

We simply do not believe it is a suitable moment to add shares, given the current market premium and the abundance of better opportunities.

Valuation

MasterCard is now trading at a forward PE of 31.12 and a trailing PE of 37.75.

This does not appear to be expensive in comparison to recent experience, but the risks to Mastercard’s business are bigger than they were previously.

Given that the S&P 500 is presently trading at a PE of 20.65, we believe Mastercard is currently overvalued.

Their growth potential and risk profile do not support nearly double the market multiple.

For the following reasons, we believe Mastercard should trade at only a 50% premium.

1. Mastercard is a reliable company that deserves a higher multiple.

2. Investors should also be mindful of the possibility of weaker growth and an increase in risk in the future.

Taking these two comments into account, we may infer that the risk/reward ratio is unfavorable at the moment, although present shareholders should do well.

Neutral Thesis Risks

Because our thesis is neutral, there are risks both to the upside and to the downside.

In terms of upside potential, Mastercard may find a means to diversify its business or significantly enhance its revenue growth and profits with the current model.

This would imply that Mastercard’s moat is stronger than expected and that it will beat our forecasts.

Some adverse risks include Mastercard’s company deterioration and its inability to deal with enormous pressure from regulators and competition.

If Mastercard is unable to retain its moat and high profits, investors will no longer be prepared to pay a premium multiple for the company.

The Most Important Thing

Mastercard is a great company, but we would not add shares at this time.

The current valuation assumes high expectations, but Mastercard may be unable to satisfy those expectations in the future.

This is a name that investors should keep an eye on and try to buy shares when the risk/reward ratio becomes more appealing.

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