Cashless Is King (AXP, MA)

By Eugene Bukoveczky | October 02, 2007 AAA

With the U.S. housing slump still not showing clear signs of having hit bottom and consumers reining in their spending, economic pundits have been upping their probabilities that the U.S. could slide into recession next year.

While U.S. retailers would be among the more obvious front-line companies to take a profit hit, another potential casualty would be credit and debit processing partners including American Express (NYSE:AXP), MasterCard (NYSE:MA) and industry giant Visa.

But just how vulnerable would they be in the event of a slump in consumer spending? Let's have a look.

Drastic Plastic
The business of handling merchant transactions has evolved dramatically since the last recession, as technology has made it a lot easier for consumers to make purchases without the need for a wallet or pocketbook full of greenbacks. The cashless society, in the form of credit, debit, smart and "swipeless" cards like PayPass has already arrived.

Card payments now account for roughly half of all retail payments and such transactions have experienced annual rates of growth that exceed the growth rate of retail sales in general by roughly 8% per annum over the past twelve years. While that growth gap is expected to narrow in coming years, continued growth due to market gains in transaction processing should provide a healthy buffer against a drop in overall retail transaction volumes. (If you're on the wrong end of the card companies' success, check out Take Control Of Your Credit Cards and Understanding Credit Card Interest.)

Monopoly Power

Another factor that works in the favor of the payments processors is the enormous market clout they wield. Retailers have long complained that they have no real choice but to sign up with one of the major card processors to handle their card-based transactions. This has lead to charges that the card companies are monopoly and should be subject to antitrust action. (To learn more, see Antitrust Defined.)

The fact that Visa was able to triple its processing charge last year from 0.6% to 1.77% without incurring any material loss of business adds weight to such charges. But it also indicates how easy it is for card processors to expand their margins and keep up their profits should volumes dip.

International Markets Key Drivers Of Future Growth
The emergence of a new global aspirational middle class who have eagerly got on board the consumption bandwagon is perhaps the most positive development for companies such as Visa, American Express and MasterCard. All now have strong and growing international franchises that are likely to continue generating strong profit growth in the years ahead given the relatively untapped nature of international markets.

Recent Selloff A Buying Opportunity?
Despite such promising long-term prospects, the recent bout of credit market turmoil has knocked-back the shares of American Express and MasterCard, which are now trading significantly below their July highs. (For more on the credit turmoil and the subprime meltdown, see our Subprime Mortgages Feature.)

While such concerns are not entirely unfounded in light of the difficulties that smaller rival Discovery Financial Services (NYSE:DFS) has had in securing funding on the interbank market, it is unlikely that big players like MasterCard and American Express would face similar difficulties. This suggests that the selloff in these shares may be a bit overdone at this point.

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