Mastercard (MA)

For those of you who follow charts, Mastercard has traced out a head and shoulders pattern which can mean that for the meantime, the stock has topped.

Notice the left shoulder being formed at the end of April '08, the head at the end of May, and then the right shoulder (lower than the left (as it should be) in June.

While this indicates that the chart has topped, this does not mean to short-sell or to buy puts. Short selling requires careful timing and people shouldn't jump into it without learning about it first.

On Dec 17, the U.S. Federal Reserve said it was considering taking steps to reduce fees that are charged to customers who use debit card. This news caused Visa and Mastercard's stocks to drop. If the Fed puts these rules in place, MA's revenues could be severely negatively impacted.

According the New York Post, the Federal Reserve may be looking to cut debit interchange rates by 40-60%. That would cut deeply into MA's profits considering every transaction made through an MA card charges an interchange fee.

Shares of Visa, MasterCard and American Express, and Capital One Financial dropped from broad industry selloffs after the US Senate voted to limit credit/debit card fees. The proposal to limit credit/debit card fees was offered as an amendment to the financial reform bill in the Senate. It limits interchange fees on debit transactions and allows merchants more freedom in setting guidlines for card use by customers but limits revenues for the credit card companies.

Senator Specter plans to introduce legislation regulating credit and debit cards that will loosen restrictions the companies place on merchants, allowing them to mandate a minimum purchase amount before a customer can use a card or impose surcharges for certain types of cards. The Electronic Payments Coalition, a consortium of banks and card companies including Visa, MasterCard and American Express, issued a news release indicating that such legislation would ultimately increases prices for merchants. The legislation would also make it easily known to merchants of the various extra fees that credit card companies charge them.

Ultimately, the legislation could help merchants increase margins, but credit card companies such as Mastercard could either lose profits from the extra fees that it normally would've charged before the legislation was put into place or it could lose customers because of the higher prices it must impose.

The stock is just too hot right here. Looking at the chart, at $310 MasterCard is trading more than 50% above its 200 day moving average. Anything 30% or higher above its 200 DMA is overbought so MasterCard is majorly overbought here.

Valuation is also stretched here. MasterCard’s net income has been inflated over the last 3 quarters to the tune of about $500 million from the sale of its stake in a Brazilian subsidiary.

Looking at free cash flow, which excludes the gains from these sales, MasterCard brought in about $800 million over the last 4 quarters. With an enterprise value around $38 billion and assuming 20% growth going forward we’re looking at a forward multiple around 40. That’s expensive for a company growing 20-25%.

It’s time to sell.

Weak position in US-based debit card PIN market, which is expected to expand greatly in the upcoming years.

Litigation pending settlement that could reach billions in payments and have unpredictable long term impacts.

Pricing pressure from merged banks with more bargaining power could drive down profitability despite increased transaction volume.

MasterCard, the world’s second-biggest credit-card company, posted a $746.7 million loss on costs to settle an antitrust lawsuit. American Express (AXP) sued MasterCard, along with Visa (V), in November 2004 after the U.S. Supreme Court ruled the companies violated antitrust laws by preventing banks from offering rivals’ cards. MasterCard said back on June 25 would pay as much as $1.8 billion to settle the complaint.

Consequently, the company showed a net loss of $5.74 per share in the second quarter compared with earnings of $252.3 million, or $1.85, a year earlier.

Excluding the expense, profit was $276 million, or $2.11 per share, beating the $2.02 average estimate of 19 analysts. Quarterly revenues grew 25% to $1.2 billion while total operating expenses excluding special items,

increased 14.6% to $830 million. General and administrative expenses increased as well, rising 15.7% on higher compensation for new personnel and bigger severance costs.

Consumers acted more like Scrooge than Kris Kringle during the 2008/2009 Holiday Season, as retail sales were down 5.5 percent to 8%. The use of electronic and card payments are becoming increasingly popular, but sales need to be made in order for payments to register. 73.8% of MA revenues come from transaction fees, so MA needs consumers to spend with their products to receive the bulk of their revenues. If we are in the midst of a recession, consumers will remain stingy with their cards until the light can be seen at the end of the tunnel.