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5 Catalysts That Could Charge Up Credit Card Stocks

By: Investor's Business Daily
Posted: 8/24/2012 2:38:00 PM
Referenced Stocks: AXP;DFS;MA;V;WXS

There may come a day when the referee will flip a plastic card on the soccer field to decide which team gets the ball first.

We are becoming a cashless society, paying with prepaid cards and digital wallets that could send checks, coins and bills into obsolescence.

The embrace of plastic like prepaid cards and the trend toward digital payment methods are key drivers for credit card firms and payment processors.

Other important factors are growth in emerging markets, share buybacks and tight business lending that's pushing some smaller firms toward plastic.

This Industry Snapshot provides an overview of these five catalysts that are driving the 24 companies in IBD's Finance-Credit Card/Payment Processing group.

The group ranked in the top 20 among IBD's 197 groups in recent weeks, though it's slipped lately.

It includes heavyweightsVisa ( V ) andMasterCard ( MA ), which only process transactions, as well asAmerican Express ( AXP ) andDiscover Financial Services ( DFS ), which issue cards and lend money.

Among the smaller players in the group areWright Express ( WXS ) andFleetCor Technologies (FLT), which provide fuel cards for fleets, andAlliance Data Systems (ADS), which issues private-label credit cards.

Building Businesses On Plastic

During his 28 years in the financial services industry, Jim Angleton has owned a mortgage financing company and a bank. Never has he seen bank lending as anemic as it has been in the wake of the 2008 financial crisis. Startups, mom-and-pop shops and midsize businesses must resort to credit cards to grow, says Angleton, president of Aegis FinServ Corp., a business-to-business firm that issues debit and credit cards.

"Over the past year, corporate credit debt has increased by 50%, making it popular to accept credit cards to move forward with business expansion or as emergency credit," said Angleton. "The average small-business credit debt is $55,000. For medium-sized companies, it's about $100,000."

With about 100,000 clients, Angleton's business issued 1,300 credit cards in June. Busier than ever, he expects to issue 60% more credit cards this year over last. About 60% of clients were Europeans -- mainly Greeks, Italians and Spaniards -- funneling money into the U.S. for fear they won't be able to access savings or get credit should the euro collapse. Foreign clients also opt for prepaid cards, which can be loaded with any currency.

Innovating Virtual Wallets

It's still early in the digital wallets game, so players from a range of industries have jumped in and hope to win.

Visa and MasterCard unveiled digital wallet platforms in the past year, months after offerings fromGoogle (GOOG) and Isis, a consortium involving wireless carriers.

MasterCard's PayPass service was unveiled in May. It will allow customers to buy products online just by clicking an icon or, when at a store, tapping a cell phone against a reader.

PayPass is set to roll out in the third quarter in the U.S., Canada, the U.K. and Australia.

Meanwhile, Visa plans to roll out its digital wallet this fall in the U.K., France and Spain. A U.S. launch date is expected in 2013. Plus Visa's payWave service is offered as a traditional card, a mini card or a small tag clipped to a key chain.

Those behind the digital wallet push expect the new offerings will catch on and help providers grow. With these new platforms, consumers benefit from a speedier checkout, while merchants rack up sales because shoppers tend to spend more when not using cash.

Analysts see each big credit card firm's existing network giving it an advantage in this field, just as it's provided an edge in other areas.

"There are high barriers to entry provided by the well-established network effects," said Brent Loder, a research analyst for Franklin Equity Group, which owns both MasterCard and Visa. "As a result of these network effects, the companies have pricing power."

Prepaid Preference

Prepaid cards are a bright spot among financial products. The market for such cards grew 24% to $184.1 billion in 2011 from $148.4 billion in 2010, according to Mercator Advisory Group.

It's grown nearly 37-fold since 2003, but there's still room to run. Only about 13% of consumers use prepaid cards compared with nearly two-thirds for credit cards.

Prepaid cards have become increasingly popular with low-income, underbanked consumers.

Nearly one in five underbanked consumers use prepaid cards as an alternative to checking accounts with fees. The cards are also popular with college students, who are now off limits for some credit card solicitations.

Emerging-Market Potential

The burgeoning middle class in emerging markets presents huge potential for electronic payments. On average, only 7% of consumers in these markets have a credit card vs. 50% in developed markets, according to a Gallup/World Bank study.

Adoption rates range from 18% in Latin America to 2% in Asia.

The total number of credit cards in China grew almost sixfold to 230 million between 2002 and 2010, according to Lafferty Group's World Cards Intelligence research service. Card volume rocketed 156 times from $4.8 billion to $748 billion in the same period. Lafferty Group projects China will become the world's largest credit card market by 2015.

"As emerging market consumers climb the social ladder, they adopt the spending habits of their American and European counterparts," said Charles Sizemore, chief investment officer of Sizemore Capital Management, based in Dallas. With more than $10 million in assets under management, Sizemore believes Visa hails as the best investment for the next 10 years.

Share-Buyback Shopping Spree

Swimming in cash, credit companies are buying back their own shares to return money to shareholders. American Express said in a March filing it could buy as much as $5 billion in shares, amounting to nearly 8% of its market value, through first-quarter 2013.

So long as AmEx keeps growing earnings, buying back shares and raising the dividend, Robert Luna plans to hang on to his position which he's owned since 2008.

The CEO and chief investment officer at SureVest Capital Management in Phoenix manages about $120 million in assets with about 2% of it invested in Amex. The stock offers exposure to financials without risks from mortgages and complicated trading schemes, Luna said.

Meanwhile, Discover announced in March that it could repurchase up to $2 billion in stock through March 2014, and Visa announced a $1 billion buyback program when it reported second-quarter results July 25.

In June, MasterCard's board authorized a new $1.5 billion share repurchase program. This program will go into effect after the company completes its current $2 billion buyback program, which has about $270 million to go.

Investment Risks

New regulations that limit late fees and interest rates could dampen profits. Sen. Bob Menendez, D-N.J., introduced legislation in December that would prohibit some prepaid debit card fees and include a wallet-sized summary of fees with the cards.

In addition, collecting on delinquent debtors has become harder. Courts have ruled against card issuers for false documents, incomplete records and poor witness testimony.

"Collections and enforcement of collections could be in the cross hairs of new laws and regulations," said Angleton of Aegis. "It will dramatically change the way cards are underwritten and issued."

The industry faces stiff competition from startups and other tech firms developing mobile wallets.

"Twenty five large retailers recently joined together to create their own mobile payments company," Sterne Agee analysts Greg Smith and Jennifer Dugan wrote in a June report. "While mobile payments have yet to gain broad consumer traction at the point of sale, battle plans are still being drawn and we will soon see more aggressive attacks coming from all sides."

Another risk: deterioration in consumer spending would dampen card volume and transactions.