Choose Discover Financial Stock Over Mastercard For Long-Term Gains?

by Trefis Team
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Mastercard’s stock (NYSE: MA) has doubled since the beginning of 2018. In comparison, Discover Financial’s stock (NYSE: DFS) is up a meager 15% during the same period. While Mastercard’s stock is up more than 6x Discover Financial’s stock, the gap in their revenue growth isn’t quite as large with Mastercard reporting 35% revenue growth over 2017-19 compared to 16% growth for Discover. Despite Mastercard’s impressive revenue growth, the difference in their stock price growth looks unjustified – leading us to believe that Discover Financial is likely a strong investment right now with significant upside potential.

Our dashboard Mastercard vs. Discover Financial: Does The Stock Price Movement Make Sense? has the underlying numbers.

 

That said, Mastercard’s profit margins (adjusted net income as a percentage of net revenues) are higher at 48% versus 25% for Discover Financial. Further, its margin figure has improved over the last three years, creating a significant difference in the profitability aspects of the two companies. Mastercard’s profit margin has jumped from 37.7% in 2016 to 48.1% in 2019, whereas Discover’s margin figure has remained stagnant around 25%. But we believe the difference alone doesn’t explain the 6x growth in Mastercard’s stock when compared to Discover Financial. Further, Mastercard’s P/E is also much higher at 36.4x based on its current market price and FY’19 EPS, while Discover Financial’s is 4.3x.

How Do The Core Businesses For Mastercard And Discover Financial Compare?

Let’s look at the core business prospects a bit more closely. Discover Financial is heavily dependent on its credit card business, which contributed around 76% of its revenues in 2019. The coronavirus outbreak has had a sizable impact on consumer spending, which could lead to lower credit card revenues in the near term – people are focused almost entirely on essentials rather than discretionary and leisure expenses due to economic uncertainty. Further, the economic slowdown is likely to increase the loan default probability of customers, negatively impacting DFS’ operations. On the flip side, it has a strong customer base, which will enable it to drive growth post the COVID-19 crisis. More information about Discover Financial’s revenues forecast over FY2020-21 is available in our interactive dashboard.

Similarly, Mastercard, one of the biggest payment processors in the world, derives around 22% of its revenues from International Fees – travel bans and widespread panic due to Coronavirus outbreak could severely impact this revenue stream. Further, lower consumer spending would result in lower transaction volume leading to lower transaction processing fees, which contributes around 34% of the Mastercard’s revenues. However, as the situation inches towards normalcy, Mastercard’s huge network of payment processors and a large customer base will enable it to drive growth post the coronavirus crisis.

In addition, while Mastercard looks more immune with its focus on the payment processing industry, Discover Financial’s isn’t far behind. In fact, with a growing presence across payment services – PULSE network, it could drive a significant chunk of its revenues from the payment services in the coming years. We believe while many of these offerings make much less money for Discover Financial than for Mastercard, they provide a promising floor to our belief of Discover Financial being undervalued versus Mastercard.

To distill, we believe Discover Financial is likely to outperform Mastercard, if not near-term, at least in the medium- to long-run.

There may be an even bigger opportunity when you compare Google to Apple.

 

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