Today I want to share with you two stocks that I have been owning for more than a decade. Priceline and MasterCard returned 1276% and 331% respectively vs. the S&P 500 return of 76% over the last 10 years!
If you have already registered to www.wealthheights.com free weekly newsletter, you would have received my free report of “4 steps that doubled my money” in which I explained my stocks selection criteria. These two stocks are consistently at the top 5 positions of my list since 2008. Both companies have lead positions in their industries, extremely high ROE (Return on Equity) which provides investors with insight into how efficiently a company’s management team is managing the equity of the shareholders and consistent profit, sales and cash flow growth year on year. have contributed to the company.
Below are some insights about both companies’ strengths and challenges from Zacks Company research dated August 21st 2017:
Share Price Outperformance- Master Card’s shared have gained 19.1% last year, outperforming 13.2% growth for the industry. Given its strong fundamentals, the stock should keep performing well in the quarters ahead. MasterCard’s strategic acquisitions, alliances and technology upgrades, along with product- diversification and geographic-expansion initiatives augur long-term growth.
Consistent Revenue Growth – Organic growth remained a key strength at MasterCard as evident by a revenue CAGR of 9% from 2013-2016. In first-half 2017 revenue growth was 13%. We believe that the company should retain its revenue momentum in the coming quarters on the back of its strong market position and attractive core business that continues to be driven by new deals, renewed agreements and expansion of service offerings. Ongoing initiatives, including digital strategy and continued widening geographic footprints create further optimism. Net revenue for 2017 is projected to grow at a low double-digit rate on a currency- neutral basis.
Accretive Acquisitions – Mastercard also remains focused on inorganic growth via acquisitions as part of its long-term growth strategy. Acquisitions added 2% each in 2014 and 2015 to the company’s revenues. Though the contribution of the same to top line was meager in 2016 these are estimated to add 2% to revenues in 2017. Recently, the company completed the acquisitions of – VocaLink and NuData Security. Both deals complement the company’s efforts to participate in new payment flows and enhance its safety and security offerings.
Strong International Operations – International markets provide both growth and diversification benefits to MasterCard. A major part of the company’s revenue is generated from international regions such as the Asia-Pacific, Canada, Europe, Latin America, Africa and the Middle East. Strategic alliances with the governments, banks and corporations in these regions along with the developed nations of Germany, the U.K., Australia, and Japan bode well for expansion into e-commerce in the emerging e-money sector. These markets have the potential to generate growth over the coming years, led by a shift toward card usage and higher consumer spending. They also remain less penetrated than the U.S. markets.
Continuous Investment in Technology – The company has been making significant progress in its digital strategy and continuously investing in technology. With MasterPass, the company became the first network to deliver a digital payment service across all devices, all channels. The company’s MasterPass service is fast gaining acceptance and is now live in nearly 34 markets. It is also investing in tokenization technology with its MasterCard Digital Enablement Service (MDES), which supports contactless payments and Digital Secure Remote Payments. In Nov 2016, the company launched artificial intelligence across its global network to provide improved consumer experience. In the first quarter of 2017, Mastercard and Samsung announced the world’s first authentication technology using iris scanning to verify online purchases on a mobile phone. Also, it recently announced the first biometric card, which combines chip technology with fingerprint scans directly on the card, to verify a cardholder’s identity. The company’s continuous investments in technology will keep it ahead in the dynamic payments’ industry.
Strong Balance Sheet Position – Mastercard boasts a strong balance sheet with financial flexibility and continuous cash generated (that has been increasing expect in 2014) from operating activities. It generated $4.5 billion of operating cash flow in 2016, up 11% year over year. Its disciplined capital management strategy by way of share buyback and dividend payments remains impressive. Last December, the company announced a new share buyback program of $4 billion and increased its quarterly dividend by 16%. The company’s current dividend yield of 0.68 is higher than the industry yield of 0.65. Also, its five-year dividend growth rate of 66.2% is significantly higher than 14.7% for the industry. We believe the company will continue to generate favorable cash from operations on the back of its growing business volumes. Its strong capital position cements investors’ confidence in the stock.
Strong ROE: Mastercard’s trailing 12-month return on equity (ROE) reinforces its growth potential. The company’s ROE of 74.9% compares favorably with ROE of 30.2% for the industry and 15.7% for the S&P 500, reflecting the fact that it is very efficient in using shareholder funds.
High Expenses – MasterCard continues to face headwinds in maintaining the cost of operations of its vastly expanded business. Total operating expenses have been increasing over the last five years (2012–2016). The same was seen in the first half of 2017 as operating expenses increased 9.4% owing to higher general and administrative expenses, interest expense and advertising and marketing costs. We expect operating expenses to increase over the coming quarters primarily due to continued investments to support strategic initiatives, increase in rebates and incentives as well as higher legal costs. For 2017, the company expects operating expenses to increase at a high single-digit rate excluding acquisitions on a currency-neutral basis.
High Rebates and Incentives – The company has been incurring quite high levels of costs under rebates and incentives to gain customers and new business. These costs drained revenues by 5% and 2% in 2016. The company witnessed a 22% increase in rebates and incentives in the second quarter of 2017, reflecting higher volumes and incentives for new and renewed deals. We believe, increasing client incentives will put pressure on the company’s bottom line. These costs are expected to dent 2017 revenues by 2%.
Loss of USAA – MasterCard’s U.S business has been soft, particularly the higher-profit consumer credit line. This is primarily due to the loss of its 30-year old key client, United Services Automobile Association (USAA), one of the largest issuers of credit and debit cards in the country to Visa. The loss of this client is a huge blow to MasterCard and is likely to put pressure on its domestic credit business through 2017.
Foreign Exchange Headwinds – With Mastercard’s vast exposure to international markets, its earnings are subject to foreign exchange risks. Its 2015 and 2016 revenues were adversely impacted by 10% and 2%, respectively, from adverse foreign exchange movement. Although forex had minimal impact on net revenue in the first half of 2017, volatility on this account can lead to fluctuation in earnings.
Overvalued – Mastercard’s valuation looks stretched at the current level. Looking at the company’s one-year forward price-to- earnings (P/E) ratio, investors might not want to pay any further premium. The company currently has a one-year forward P/E ratio of 30, which is above its median range of 27.8. It is also higher than the one-year forward P/E ratio of 25.3 for the industry and 19.2 for the S&P 500.
The online travel booking segment has secular growth drivers. The biggest of these is the shift from offline to online booking challenges. The strong growth rates might lead one to believe that growth through this channel is reaching its zenith especially given the proliferation of mobile devices. But the travel market is extremely fragmented, so significant growth opportunity remains. Second, many international markets have significantly lower penetration rates than the U.S. Third, there is a growing middle class in many geographies that increasingly lives online. This is a segment companies like Priceline are extremely well positioned to tap. And fourth, the company does have a world-class platform which helps it win this business.
Priceline has been able to maintain a steady growth rate and gain market share by offering its products at discounted prices and creating increased awareness of its brands. The company also offers superior content than its peers and has a positive balance sheet and cash flow metrics. The company aims to enhance its free cash flow and shareholder value in the long term. We believe Priceline will continue to benefit from continued market share gains. Increasing Internet usage will contribute significantly to the company’s growth going forward.
Priceline generates the bulk of its business from international markets where growth prospects are greater than in the domestic US market. According to PhoCusWright, online travel booking in Europe is growing at a faster rate than in the U.S. with penetration rates already higher. Since Priceline is very strongly positioned here, it will be able to benefit from increasing penetration rates. Latin America and Asia Pacific are at a nascent stage, but are believed to have significant long-term growth potential. Priceline has increased focus on these regions through Agoda, booking.com and more recently, Ctrip. Priceline’s agreement with Ctrip enables it to share inventory and thereby capture outbound traffic from China. It is also able to use Ctrip inventory for people looking to travel to China. Given the adverse currency situation that is impacting not just Priceline but many other technology companies, growth rates may be somewhat slower this year. But business trends are likely to remain extremely strong for several years into the future.
Considering Expedia’s dominant position in the North America OTA market and the associated brand power, Priceline has taken a relatively cautious approach to the market. Given that its Booking.com brand has a strong position in Europe, the company is in a position to leverage the brand to capture a share of international travel into the U.S. Its agreement with and subsequent investments in Ctrip have also furthered this objective. The company has also launched the Villas.com vacation rentals brand under the Booking.com umbrella. Villas.com has one of the largest inventories in the category. It also acquired OpenTable to further beef up its domestic business. Priceline has supplemented these initiatives with brand-building actions using both online and offline channels. Most notable of these was an agreement with TripAdvisor to join its Instant Booking platform. While still a very small part of its business, this could familiarize the brand with Americans. Management said in the last earnings call that the arrangement was working on track with expectations.
Priceline’s sales approach enables it to serve both premium and cost-conscious customers, at the same time helping to mobilize its suppliers’ excess room nights. Room nights not used are lost forever and the low occupancy rate lowers margins for the seller. Priceline’s opaque business takes care of this problem by selling suppliers’ excess room nights to cost conscious customers at a discount. Customers’ preferences regarding the kind of accommodation/car/etc are considered, but the supplier’s name is not disclosed at the outset. This protects supplier pricing models, while helping them mobilize inventory. It also generates additional revenue for Priceline. However, as more competitors adopt the opaque model, growth rates through its adoption are likely to slow. It also doesn’t do as well when the travel market strengthens simply because there is less available inventory. The “name your own price” model is popular even among airline companies.
Priceline has been increasing advertising spend. Management is trying to take share in the U.S. for which it has embarked on an extensive offline brand advertising campaign in addition to continuing strong online advertising. As a result, performance and brand advertising expenses increased significantly in the recent years. Total performance advertising expenses were a respective $3.5 billion, $2.7 billion and $2.3 billion in 2016, 2015 and 2014. Total brand advertising expenses were $296 million, $274 million and $257 million, respectively in 2016, 2015, 2014.The increased advertising spend is necessitated by the fact that the company has a very strong competitor in Expedia in the domestic market. Capturing mindshare involves sustained investments in brand building, so this expense is not necessarily a negative although it can negatively impact results in the near term.
Despite significant investments as well as branding and promotional initiatives, the domestic business remains small. Priceline tried to leverage its Booking.com brand and Ctrip investments to build the business, but these efforts have not yielded desired results as yet. There were also high hopes of the OpenTable acquisition adding to its growth, but this too doesn’t appear to have materialized, since growth rates have in fact come down since then. Limited presence in the domestic market is particularly significant in the current environment because the stronger dollar is increasing the cost of travel for inbound tourists and thereby impacting these sales. On the other hand, cost of travel for Americans has fallen with the dollar strengthening, which although good for outbound travel, is not an opportunity the company can exploit because it doesn’t have good brand position yet.
Management has cautioned about declining ADRs. While currency has been the main reason for the decline, there are also other factors, such as the increased demand in Asia and Russia (where it carries lower-ADR inventory) coupled with weaker demand in France (where it has higher-ADR inventory) resulting in a negative mix. Geographic and macro factors tend to change from period to period however, so if ADRs don’t pick up despite currency becoming less of a factor, there may be market or competitive concerns. For instance, large hotel chains like Marriott, Hyatt, Hilton and InterContinental have started offering discounts to travelers booking directly with them. Priceline maintains that it has a unique platform with better distribution capabilities that the chains value, but this is definitely an area we should keep our eyes on. It would make perfect sense for the OTA to take down prices if hotels decide to offer discounts.
Similar to other online travel companies, Priceline is also facing a significant amount of litigation. This is mainly because there seems to be a doubt about whether its revenue is taxable under the tax ordinances applicable to hotels. It has been argued that had the hotels charged customers directly, they would have charged higher rates than they charge the online travel companies, which acquire inventory at wholesale prices. Therefore, a higher amount would have come under the ambit of occupancy tax. Just because the revenue is now being split with a booking company, there is no reason for it to be exonerated. The arguments in favor of the online travel companies are first, they do not own or operate hotels. Second, they are already collecting and remitting to hotels the tax on wholesale prices which are being paid by the hotel. And third, offline selling agents are not required to pay occupancy tax, so there should not be an exception for online agents. However, certain facts have come to light regarding the taxes collected by online travel companies. It appears that they have been collecting cash from customers in the name of occupancy taxes on the retail value of rooms sold, but remitting taxes on wholesale prices to hotels, keeping the balance. Online travel companies have been winning some cases and losing some, but they have had to pay significant amount of taxes in some states.