The U.S. economic recovery resulted in a remarkable decline in the unemployment rate from 10.1% during the financial crisis of 2009 to 7.4% in July 2013. The declining unemployment rate indicates an increase in disposable income for U.S. citizens, resulting in improvement in the spending environment. With the increased spending trend of U.S. consumers, which is more than 90% of their total disposable income, the credit service companies have a new ray of hope. At the same time, emerging markets like Asia, where the electronic payment penetration is very low, are providing enormous opportunities for these companies to grow. Let's see what opportunity lies for industry giant Visa (V)
Durbin amendment, the battle continues
The Durbin amendment to the Dodd Frank Bill, required banks with more than $10 billion in assets to have two independent networks for their debit card transactions, one for signature based and one for PIN based. It attempted to reduce prices by introducing competition between payment card providers Visa and MasterCard (MA). Currently Visa has 72.7% market share in the debit card market. Due to this non-exclusivity provision, the debit card market will split between Visa and MasterCard in 50-50 proportion. MasterCard has reported a 15% increase in payment volume in fiscal year 2012 as compared to Visa's 1% in the U.S.; this resulted from the market share gain. The U.S. accounts for 39% of MasterCard's total revenue and debit card accounts for about 50% of the U.S. market's total gross dollar volume, or GDV, which is the dollar amount of purchases made by MasterCard's customers. We expect MasterCard to maintain the GDV growth in the fiscal 2013.
The amendment also requires the bank to reduce the interchange fees. On July 31, the U.S. District of Columbia judge, Richard Leon, gave a ruling on the lawsuit filed by the National Retail Federation. The judge ruled that the current debit card interchange fee does not protect the merchant's interest and required the interchange fees to be reduced to $0.12 from $0.21. The cardholders' bank charges the merchants' bank interchange fees. The payment card companies, like Visa or MasterCard, don't get anything from these fees, rather they earn from transaction fees. Therefore, there is no direct impact on payment card companies' revenue from this ruling. On the other hand, the banks are asked to charge less for the transaction so their revenue from debit cards will reduce, which restrains then from marketing debit transactions with their customers, which effectively reduces debit card usage in the long run, affecting the payment card company's revenue.
Also read our previous coverage on this issue here: Visa: Is The Court Ruling An Alarming Sign For The Bulls?
Following the ruling, on August 21, 2013, the U.S. Federal Reserve has appealed to the higher court to revisit the interchange fee ruling. We expect this legal battle to continue until the end of 2014. Until then, banks will charge the same interchange fees and debit card networks will benefit from the growth in the transaction volume. In the last quarter, Visa's revenue grew 13% year over year in the U.S. This rise in revenue is coming from organic growth as the U.S. economy and the job market improves. We expect the momentum will continue until there is a final decision in the legal battle.
Market reach ensures cash flow
The economic improvement is acting as a tailwind to Visa's business. Visa generates more than 50% of its revenue from the U.S. market. The company reported an increase of 11% in payment volume, the credit volume grew by 10%, and the increase in debit volume was 12% in the quarter ended in June 2013 year over year. In 2012, 26.1% of all electronic transactions were made on Visa's network. It has the highest merchant penetration in the U.S. with 88 locations per 1000 urban households. It accounted for 40.7% of total electronic payments made in the U.S. in 2012. Looking at Visa's market presence, its GDV from the U.S. market will continue to grow at 6% year over year to $2.645 trillion in fiscal year 2013.
Emerging and promising
In 2012, Visa reported a volume increase of 15% in GDV from outside the U.S. market. The emerging markets like India and China are opening up new opportunities for the payment card industry. According to a study by BCG, by 2020 the combined consumer spending of India and China will triple the level spent in 2010, reaching $10 trillion. Countries like India, where the electronic payment penetration is as low as 0.09%, have opened a huge opportunity for Visa. Electronic payment is gaining momentum in these countries. To get a better picture, the Indian Railways on-line ticketing has successfully adopted the electronic payment route and it is generating a volume of 180 million transactions per year. This highlights the importance of emerging markets. Visa has a strong presence in these markets and given the increasing penetration of card transactions, we expect it to maintain the 15% GDV growth from outside the U.S. market in fiscal year 2013.
Other players are also gaining from the momentum
Meanwhile the improving market conditions have given a positive push to other players as well. More than 65% of total revenue for American Express (AXP) comes from the U.S. market. In the last quarter ended in June 2013 the average amount spent per customer on an American Express card has increased by 4% from $3,948 to $4,097 year over year. Currently the company has 31.3 million proprietary card users in the U.S., which increased by 0.3 million in the second quarter, an increase of 3% year over year. Looking at the growing trend, consumer spending is expected to grow by 6% year over year in fiscal year 2013. We expect American Express to grow at the same rate. With the given rise in revenue and a profit margin of 15.27%, the company will have profit gains of more than $1.206 billion or an EPS contribution of $1.10 from the U.S. market.
We at Fusion Research believe that the revival of consumer spending will drive the top line for Visa, which will reflect in its earnings. The company is trading at a trailing 12-month, or ttm, PE multiple of 21.30 with a forward PE of 19.69 until the end of fiscal year 2014, which suggests an EPS of $8.89 for fiscal year 2014, an increase of 8.17%. With the current market condition, it won't be difficult for the company to maintain this level.
A comparative analysis
The other two major players in plastic cards are MasterCard and American Express. MasterCard is the second biggest player and has a ttm PE multiple of 25.24 with a forward PE of 19.90, which indicates a growth of 26.83% in earnings in fiscal 2014. Also, American Express has a ttm PE multiple of 17.68 with a forward PE of 13.49 giving a growth indication of 31.06% in earnings.
Expected EPS (2014)
Source: Yahoo Finance, 29th August, 2013
The improvement in consumer spending in the U.S. complemented the increased penetration in emerging economies, and all major players in the plastic money universe will gain. Visa's revenue relies heavily on the U.S. market, and its shrinking debit card market share may result in lower revenue but the improving economy will offset the impact of losses.
The other major players, MasterCard and American Express, have a better outlook than Visa since MasterCard is gaining market share in debit cards due to regulatory changes and American Express is riding the growing spending wave from its affluent customer base.
Due to the changed regulation, Visa's outlook in the U.S. debit card market is dicey, but looking at the consumer credit growth of 6% in the U.S. and the GDV growth in emerging economies, we expect the stock to remain range bound. We continue our hold rating on this stock.