Mastercard Inc. (MA), the digital payment network company (not a credit card), reported excellent results for Q3 on Oct. 26. This included large volume increases in data transactions along with massive adjusted free cash flow (FCF). This FC is financing its splurge on stock buybacks that will likely help push MA stock even higher.
Mastercard said its revenue rose 14% YoY and its gross dollar volume was up 11%. Mastercard charges fees based on this volume so this is a good sign for the company's revenue going forward.
Moreover, its adjusted net income earnings per share (EPS) rose 26% to $3.39. This was significantly higher than analysts' estimates of $3.09 EPS for the quarter.
Free Cash Flow is Still Powerful
But even more important the company generated $3.233 billion in cash flow from operations during the quarter and free cash flow (FCF) of $3.129 billion. This is based on figures produced by Seeking Alpha.
That is important since it represents over 120% of its $2.595 billion in adjusted net income, based on page 12 of its earnings presentation. In other words, the company is gushing forth cash.
Here is another way to see this. The company's Cash Flow Statement on page 9 of its earnings release shows that so far this year as of Sept. 30 it has generated $7.85 billion in cash flow from operations. After deducting $294 million in capex spending and $525 million in capitalized software spending, its adj. free cash flow is $7.03 billion in the first 9 months of 2023.
That represents 37.9% of the $18.55 billion in revenue so far this year. This is a very high adj. FCF margin. Moreover, the company is using this to buy back large amounts of its shares.
FCF finances Buybacks and Dividends
For example, the cash flow statement shows it has spent $7.2 billion in share buybacks. This is in addition to $1.2 billion in dividend payments. In other words, it has already spent $8.4 billion on shareholder capital returns. As a result, the free cash flow the company generates provides the bulk of the financing for these shareholder returns.
This means that on an annualized basis shareholders could expect to see up to $9.6 billion in buybacks. That represents 2.75% of its present market cap of $349 billion. This is a very high buyback yield.
This helps enhance the annual dividend dividend payments of $2.28 per share which give investors a 0.6% dividend yield.
Enhancing Income with Covered Calls and OTM Short Puts
Investors can enhance this yield by selling short out-of-the-money (OTM) puts and calls. For example, for the period ending Nov. 24, which is 24 days from today, investors who own MA stock can sell the $400 strike price calls. They trade for a premium of 81 cents, which represents a covered call yield of 0.215% on today's price of $376.52 per share.
If that is repeated every 3 weeks for a year, the annualized expected return is 3.655%. This is because there are 17 periods of 3 weeks in a year. Moreover, since the $400 strike price is over 6.3% from today's price, the investor stands to make an additional capital gain if MA stock rises to this level
Moreover, selling short OTM puts also makes sense here. For the same period, the $350 strike price, which is over 6% below today's price, trades for $1.14 per contract. That provides an instant put yield of 0.33% (i.e., $1.14/$350).
Moreover, if repeated over a year that provides an annualized expected return of over 5.5%.
This shows that using out-of-the-money puts and calls is a good way to make additional returns with an investment in this profitable company
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
