The payments space is highly attractive for stock investors. Virtually all payments companies are benefiting mightily from the long-term switch away from cash and toward electronic payments -- a trend that isn't stopping anytime soon.
In addition, all the big payments players seem to have large economic moats. Being a leader gives incumbents the ability to invest in the latest technology and security solutions, as well as develop new products from their troves of payments data.
And once a large network is established, very often it doesn't require much in the way of additional investment, meaning these companies generate lots of operating leverage, or profit growth well above revenue growth. Payments leaders also generate tons of cash flow, which their management teams often redeploy into value-add acquisitions or share repurchases.
Two such leading players today are Mastercard (NYSE: MA) and PayPal (NASDAQ: PYPL). So, which is the better pick at the moment?
PayPal and Mastercard are both dominating digital payments. Image source: Getty Images.
Though both companies are payments giants, Mastercard and PayPal operate on slightly different parts of the payments value chain. Mastercard is one of only a few large networks that connect a merchant's acquiring bank and a consumer's issuer bank for authorization and clearing, and the company collects fees for processing transactions on all Mastercard-labeled credit, debit, and pre-paid card transactions. Mastercard is also venturing into more-direct business-to-business (B2B) and peer-to-peer (P2P) payments as well, via both organic investments as well as a string of recent acquisitions.
PayPal, on the other hand, was developed initially by eBay to facilitate digital transactions on its online auction site. But PayPal soon became a powerhouse in its own right as it was a first mover in facilitating digital payments for most e-commerce transactions. In 2015, it was spun off into its own entity, and it now enjoys a wide lead facilitating "one touch" online transactions that don't require a customer to enter a card number over and over. It has already expanded to about 70% of all online merchants.
PayPal has also made significant acquisitions in the past few years. These include the 2013 addition of Braintree, a merchant payments processor, and its subsidiary Venmo, a leading P2P platform. This was followed by the 2015 acquisition of Xoom, an app for international remittances, and the 2018 acquisition of iZettle, a Swedish card point-of-sale software company not unlike Square. This year, PayPal turned things up a notch, with large strategic investments in ridesharing leader Uber (NYSE: UBER) and Latin American e-commerce juggernaut MercadoLibre (NASDAQ: MELI).
While the companies are slightly different, both Mastercard and PayPal make money from transaction fees, and thus they depend on expanding gross merchandise volume (GMV) flowing through their platforms. PayPal used to lend out money through its PayPal Credit arm, but sold those loan receivables last year, becoming a pure-play processor.
Growth and recent results
Both platforms have performed rather well recently, parlaying their competitive strengths into low-to-high-teens revenue growth in the second quarter:
Q2 2019 Metric
Transaction revenue growth
Operating income growth
Data source: Mastercard and PayPal Q2 earnings releases.
As you can see, Mastercard is a bit more mature and larger than PayPal and thus growing a bit slower. Interestingly, Mastercard didn't generate positive operating leverage in the last quarter, as it is investing heavily in growth initiatives and recent acquisitions. PayPal, on the other hand, is growing faster and generating positive operating leverage, and this is despite revenue slightly underwhelming analyst expectations last quarter.
One possibility for PayPal's discount could be that investors are fleeing to "safer" stocks lately in response to the uncertain overall economy. Mastercard, which owns a basic core network upon which all its branded cards travel, is more of a core infrastructure business than PayPal's digital payment ecosystem, which is a higher layer, and thus perhaps a bit more susceptible to competition.
PayPal still seems like the pick
Both companies are very solid, wide-moat stocks that should continue to grow. But of the two, PayPal appears to be the better buy at the moment. Not only is it growing faster, but that growth actually underwhelmed analyst expectations last quarter, as some large-scale partnerships were pushed out to later in the year.
Though that led to a decline in the stock, management strenuously reiterated that those delayed projects are a matter of "when, not if." Since some of the projects were delayed because they were larger than originally expected, they could even be seen as a positive for PayPal longer term. Thus, after the stock's recent swoon, now may be the better opportunity to pick up PayPal shares while they're on sale.
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Billy Duberstein has no position in any of the stocks mentioned. His clients may own shares of the companies mentioned. The Motley Fool owns shares of and recommends Mastercard, MercadoLibre, PayPal Holdings, and Square. The Motley Fool has the following options: short October 2019 $37 calls on eBay, short October 2019 $97 calls on PayPal Holdings, long January 2021 $18 calls on eBay, and short September 2019 $70 puts on Square. The Motley Fool recommends eBay and Uber Technologies. The Motley Fool has a disclosure policy.
This article was originally published on Fool.com