A Look at Credit Card Companies
Updated: Jul 19, 2020
For the avoidance of doubt, I am not an investment advisor and am not licensed to provide investment advice. The information I am presenting is generally believed to be true, but much was obtained from third-party sites like Yahoo Finance. These are not buy or sell recommendations. These are ideas regarding companies only, and any decisions you make to invest in them, are your own. Of the four companies I am writing about below, I own Mastercard.
A couple of people asked me recently about credit card companies, so I thought I would look at four of the largest: #Mastercard, #VISA, #American Express and #Discover Financial Services. Each of these companies has a different business model, although all four are payment processors. Mastercard and VISA are similar, in that both are payment processors only; they do not issue credit cards and therefore do not provide credit directly to users. Instead, a variety of banks (e.g. Citibank, Chase, Bank of America, Wells Fargo, etc.) issue credit or debit cards using one of either Mastercard or VISA to process each transaction. American Express and Discover are different in that these two credit card issuers also provide credit card loans directly to their customers. This means that the income statements, asset bases and risk profiles are very different for American Express and Discover compared to Mastercard and VISA. As far as revenue streams, Mastercard and VISA generate payment transaction fees only, whilst American Express and Discover have two streams of revenues - net interest income (from their respective loan books) and payment transaction revenues.
With the investment community mixed on whether or not the equity markets might at some point soon test new lows because of the dire economic circumstances related to the COVID-19 pandemic, one or more of these companies could – at some point - represent an attractive investment proposition. Both VISA and Mastercard look richly priced to me at the moment although analysts following both companies have consensus price targets above current levels. (Analyst’s consensuses for share prices of both Discover and American Express are also above current levels.) Discover looks like the most interesting stock as a value play at the moment, although there will be mounting concerns with the company’s loan book as the crisis deepens, and this is most certainly reflected in the current stock price and very low P/E (3.9x trailing). American Express is more expensive (P/E of 10.8x trailing) but should suffer less as far as its loan book as economic conditions deteriorate.
This post will have three sections. The first looks at each of the four credit card companies in summary format, including the most recent two years of its share price performance. The second section provides a comparable table with more detail on each company and its shares. This section also includes a 5-year graph that shows the relative performance of each company. The last section is commentary, looking at the factors that could affect the operating performance and share performance during and after this crisis.
1. Credit Card Company Profiles and Two-Year Share Performance
2. Comparable Table and Five-Year Share Relative Share Performance
3. Commentary and Factors Affecting Future Performance
Different business profiles mean different risk profiles: As mentioned, Mastercard and VISA are pure payment processing companies, meaning that they take a small percentage of each transaction that runs through their platforms but do not take the credit risk of people using their credit cards. Discover and American Express are different in that both own banks. Therefore, both lend money pursuant to their credit cards and process their own transactions. Unlike American Express, Discovery runs a broader lending business including home equity loans, student loans and consumer loans, accounting collectively for 20% of the company’s loan book (with credit cards accounting for the remaining 80%). The fact that American Express and Discover are (or own their own) banks means that they will have larger balance sheets and more earnings volatility than VISA or Mastercard. A weak economy will inevitably lead to more defaults, reducing net interest income – and earnings - for both Discover and American Express.
Customer base metrics / demographics: VISA, Mastercard and Discover are primarily middle market focused as far as their credit cards, whilst American Express is focused on a more affluent customer base. This is perhaps best illustrated by looking at the $ volume / cardholder (see profiles and comparable table), in which the customers of American Express charge substantially higher amounts (around four times) than the customers of their peers. American Express has lower provisions and charge-offs than Discover reflecting the better performance of their loan book during economic downturns. As far as other demographics, Mastercard has the most internationally-held card of the four companies and Discover the least. VISA is the largest credit card company by a decent margin and Mastercard is second. Both American Express and Discover have significantly fewer cardholders than VISA and Mastercard.
COVID-19 Will Affect the Performance of These Companies: The current economic hiatus in many parts of the global economy will negatively affect all four of these companies to different degrees, with American Express and Discover being more adversely affected because they are lenders. Here’s why:
Transaction Fees: Consumers are obviously spending less than they were before COVID-19, as retail shops and restaurants remain shuttered, sporting events have been cancelled, and travel is curtailed in many parts of the world. This negatively affects the payment transaction income of all four companies, since this revenue stream is tied to the number and $ volume of transactions. There are two counter-arguments that might help soften the blow of lower volumes. The first is that people are shopping more online than before the shutdown, and these transactions either use credit or debit cards (or PayPal), but obviously not cash. The second is that this pause will accelerate the movement, already well underway, from a cash/paper transactional economy to a plastic/digital transactional economy. Both counter-arguments are true but it is unclear as to just how much these factors will offset the severe drop in number and $ volume of transactions vis-à-vis the pre-COVID-19 situation when retail establishments and restaurants were open, sporting events were occurring, people were travelling, and life was otherwise “normal”.
Credit Losses: Even with unprecedented amounts of monetary and fiscal stimulus unleashed in the U.S., the U.K. and other countries, the expectation is that consumers will struggle to keep up with their loan payments, including credit card payments, mortgage payments, car payments, student loan payments, and so on. Provisions will increase for lenders to reflect expected higher defaults and charge-offs. This will adversely affect the net interest income for Discover and American Express, since both are lenders, but will have no effect on Mastercard or VISA. A previously mentioned, the more affluent customer base of American Express should provide this company with more cushion than Discover.
Ratings / Access to Funding: All four of these companies are investment grade rated. Discover and American Express are not rated as highly as VISA or Mastercard because of their business profile, but both companies are investment grade rated and are able to access the short-term and long-term funding markets, a lifeline for any lending institution. American Express and Discover have larger balance sheets, as would be expected, because they are carrying their own loans pursuant to their credit cards (and other types of loans, too, for Discover). Mastercard and VISA are both rated higher than American Express and Discover, with VISA being slightly higher rated probably because it is larger and has a broader and more diverse scope of business than Mastercard. Both payment processors also have higher margins and better returns on assets.
P/E Ratio: The pure payment transaction companies (VISA and Mastercard) have higher P/E’s than credit card issuers Discover and American Express. It is in fact not really fair to compare P/E ratios across the two business models, but rather only within the same business model. The P/Es of Discover and American Express, since both are banks (or own a bank), should be compared to other banks. My view is that the P/E ratios for Mastercard and VISA are still very high. American Express looks about right given its business mix, and Discover looks very low, certainly relatively speaking, presumably because of the less favourable demographics of its customer base. Mastercard has a slightly higher P/E than VISA.
Dividends: All of these companies pay dividends. The yields for the credit card issuers American Express and Discover are higher than the yields of the pure payment processors. This might be attributable to the more severe decline in the prices of Discover and American Express since the sell-off, with American Express shares 37% below their high and Discover shares 62% off of their high. A reduction in dividends is possible for both American Express and Discover as their earnings deteriorate, but Discover is most certainly at greater risk if the quality of its loan book deteriorates more severely as expected. Between the payment processors, VISA has a higher dividend yield than Mastercard.
Stock Performance during Prior Recessions: One other thing I looked at is the share price performance of these companies compared to their performance during the dot.com bust and the Great Recession. As you can see from the table, it took the credit card issuers much longer to reach their pre-recession highs (around 5 years) than it did the pure payment process companies (2 to 3 years). Having said this, also note that VISA and Mastercard have only been public during the most recent “Great Recession” but not the dot.com bust, so there has only been one period to test the recession performance of these two companies.
Subject to all of the disclaimers and caveats I have mentioned, my view is that VISA represents the most attractive stock should prices come off again. However, it is hard to conclude that a 30x P/E is attractive in the midst of the severe recession we are in at the moment. If you are open to taking bank risk, then as much as I like the brand “American Express”, Discover would represent better value. But it is also more concentrated geographically, has a loan book that is only 80% credit cards, and will inevitably suffer more as borrowers default. If you can stomach this, then perhaps you might prefer Discover for its (potential) value play, although I believe that American Express is valued more highly from a P/E/ perspective simply for its quality. As I mentioned in the post recently on Microsoft, now is the time to do the work to be prepared to buy one or more of these stocks should the market take another turn down.