Visa Rally May Be Short Lived

Investors in Visa Inc. (V) as well as MasterCard Incorporated (MA) had reason to cheer last week as stock prices advanced sharply. Visa reported earnings of $0.78 for the quarter ending December 31. This beat consensus expectations which were expecting earnings of just $0.66. After the announcement, the stock rose 11.3% in just two days.

The rebound was good news for investors who had held the stock since the IPO in March of 2008. These investors had purchased the stock at a price of $44 which has turned out to be an area of support on the chart. In fact, this level was in danger of being broken in late January until a rebound in the market allowed the stock to re-take its IPO price.

Ironically, the primary reason that Visa beat estimates is not because revenue levels were high. In fact, US transaction revenue was actually flat with last year’s level. US credit card transaction volume was down about 6% and US debit card volume was up enough to net those losses out to roughly zero. The revenue growth came from international transaction volume, and the earnings beat actually came from significantly lower expenses.

Now, I have utmost respect for a company that is able to cut its expenses during a weakening market in order to operate profitably. However, the bottom line is that Visa is not immune to the global recession which is why management is dealing with expenses so aggressively. Advertising and marketing remained at $210 million for the quarter which is flat with the end of last year. This is not the type of action you would expect to see out of an aggressive growth company.

I’m actually a bit surprised that management is not increasing its marketing budget in order to capture market share and strengthen its competitive position. The fact that Visa has pulled back spending to this point is a testament to just how difficult this current environment really is.

Looking to the quarters ahead, management has reiterated their commitment to growing earnings by roughly 20%. At this point, it looks like that growth will be from cuts in expenses instead of due to actual revenue growth. This game can only be played for so long. Once excess expenses have been cut, management must make the decision to cut necessary projects, which end up affecting long-term revenue growth, or else abandoning the 20% earnings growth target. Neither of these choices will likely have a positive effect on the stock.

On a macro level, Fitch recently commented on credit card issuers stating that late payments on US cards topped record levels. Last month default levels rose sharply and Fitch expects the credit card Asset Backed Securities to worsen because of the delinquency rates. Investors in Visa and MasterCard will argue that this doesn’t matter because these companies simply process the transactions and do not have credit risk.

But credit risk eventually affects Visa because as banks deal with increasing credit risks, they will begin to issue fewer cards which means slower growth or even a decline in the transaction revenue. International markets are facing similar problems and while they may not be saturated to the point that the US markets are, the anticipated growth in international market is likely too optimistic.

I read an interesting article in the New York Times this weekend about increases in bartering as a method of payment in Russia. This is due to the sharp decline in the ruble. It may sound a bit dramatic, but I wonder if a decline in the purchasing power of the dollar could eventually lead to increases in bartering as a means of payment instead of cash transactions. Russia saw this type of exchange account for as much as 50% of revenue for many mid-sized business during times of extreme stress.

It is difficult to suggest shorting Visa in the face of the strength we saw last week. But one method of playing this situation would be to buy puts on the stock. That way there is a finite amount of capital invested, but once the stock loses its momentum, put buyers could profit handsomely. The timing is difficult to call, but I anticipate Visa shareholders experiencing frustration in the coming months.

V Notes

Disclosure: Author does not have a position in V.

Comments

[mr freddo:]

Thanks for the well written article. I picked up V at the public offering and was looking to take some profits now that it is back in positive territory.

Feb 09 03:39 AM

[Joel DErrico:]

Hey Zach...How come Visa had a 10% increase in card holders?????? It has made money every quarter since going public the best way to foretell the future is the past you have to be realistic about the marketing and promotional and factual strength of this company

Feb 09 06:49 AM

[knightowl1953:]

Your macro analysis is correct but I disagree with your micro analysis. Visa is not immune to this crisis. I agree. But the dynamics of Visa have not changed. People all over the world are turning to cashless transactions. Debit card use has and will continue to increase. Substitution is also a factor. Instead of using plastic for that big screen TV cosumers are using the card more and more for necessities. Yes, this economic crisis may affect Visa just like every other stock. But long term, yes please think two years from now, Visa will surpass MA as it takes its place as the leader of the financial card pack.

Feb 09 08:50 AM

[WACG:]

If you do not have a position in Visa why do you feel the overwhelming need to flap your yap about it?

Feb 09 09:58 AM

[Obi-Wan:]

Bartering to replace credit card usage??? Good grief, I am not believing what I am reading.

I suppose everyone is entitled to their opinion. Not like anyone is being graded for reasonableness of theory or anything......

Feb 09 02:01 PM

[Urbane Gori...:]

I wonder if the 10% increase in card holders has been offset by the reduced limits on their membership.....

Also like to just comment that some people are **in love** with their stocks. So much so that they beat up the author for even voicing an opinion... Even Jim Cramer says that these are just pieces of paper.... Gotta remember to add V to the other two companies you never bad mouth... POT and AAPL...

jegan ;-)


On Feb 09 06:49 AM Joel DErrico wrote:

> Hey Zach...How come Visa had a 10% increase in card holders??????
> It has made money every quarter since going public the best way
> to foretell the future is the past you have to be realistic about
> the marketing and promotional and factual strength of this company

Feb 09 06:09 PM

[Ken714:]

Let's not forget that cost cutting was discussed in Visa's prospectus, before they even went public, that one of their main goals of the IPO was to restructure the company and reduce costs to improve earnings. Cost cutting to improve earnings is no secret to Visa shareholders, Visa has continued to mention this in all of their conference calls. Visa's two main goals of bringing the company public was to cover litigation expenses and restructure the company to reduce costs. So far they have done a beautiful job of reaching both their goals and have managed to increase shareholder value in the process.

If you would excuse me I am going to go shred my credit cards and hunt for some fur pelts so I can trade them for produce.

Feb 09 10:14 PM

[who:]

In the long run this is great company and I've made some serious money after its IPO. But, this global recession (or depression) is severe. Cost cutting is great, but no new business means no new growth. Overseas markets are seeing growth, but will their default rates increase in turn reduces credit hence hamper new transactions?

Feb 09 11:00 PM

[Joel DErrico:]

One last comment..I note that Zach's interest is in Hedging..Does he like to use the word SHORT whenever he can?

Feb 10 08:17 AM

[Prudy:]

Your comments on the possible reduction in credit cards issued by financial institutions are correct, but what about debit cards and beyond that, other new forms of electronic payment.

You mentioned the support level at or around the IPO price; isn't there something to be said for a financial stock which is roughly flat over the previous 12-months?

Feb 10 10:12 AM

[jd2iv:]

it amazes me that people continue to go long Visa and Mastercard. The only days the stocks are up are on about half the volume...and when the stock goes up...its just retarded uneducated investors picking up the stock at the ask. all that means is there are smarter, stronger institutions behind the asks and they are going to sell their shares as high as they can. When are retards going to stop coming into the market and picking up terrible stocks at the ask? wonder why you get taken to the cleaners on every trade?

Feb 18 11:27 AM