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With consumers steering away from cash in favor of the convenience of credit and debit cards, companies that offer these products are expected to see significant growth over the next few years. As the number of cashless transactions is increasing globally, year over year, Visa Inc. (V) is a global payments technology company set to capitalize on this growing trend.

Visa is a company that connects consumers, businesses, banks and governments in more than 200 countries and territories around the world. Unlike American Express (AXP) or the Discover card (DFS), Visa Inc. does not issue cards, set cardholder fees, interest rates, or make loans to cardholders. The cardholder relationship belongs to Visa's network of financial institution clients and are managed by them. Visa derives revenues primarily from fees paid by these financial institutions based on payments amount, transactions that Visa process and other services that Visa provides.

Over the past couple of years, Visa has had some issues that have greatly effected the business. The Durbin amendment which was added to the Dodd-Frank bill requires banks with more than $10 billion in assets to use separate payment processing networks for signature authorized and PIN authorized debit card transactions. This amendment has greatly effected Visa revenues over the past couple of years. The effects of this amendment are visible in the section below.

Using the analysis below, I will analyze the past four years of Visa's performance. I will look at Visa's past profitability, debt and capital, and operating efficiency. Based on this information, we will look for strengths and weaknesses in the company's fundamentals. This should give us an understanding of how the company has fared over the past few years and will give us an idea of what to expect in the future.

Profitability

Profitability is a class of financial metrics used to assess a business' ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net income, operating cash flow, return on assets and quality of earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.

  • Net income 2010 = $2.966 billion
  • Net income 2011 = $3.650 billion
  • Net income 2012 = $2.144 billion
  • Net income 2013 TTM = $5.450 billion

Over the past three years Visa's net profits have increased from $2.966 billion in 2010 to $5.450 billion in 2013 TTM. This represents a 83.75% increase.

V Net Income TTM Chart

V Net Income TTM data by YCharts

  • Operating income 2010 = $6.236 billion
  • Operating income 2011 = $7.272 billion
  • Operating income 2012 = $4.279 billion
  • Operating income 2013 TTM = $9.371 billion

Operating income is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

Over the past three years Visa's operating income has increased from $6.236 billion to $9.371 billion in 2013 TTM. This represents an increase of 50.27%.

ROA - Return On Assets = Net Income/Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

  • Net income growth

    • Net income 2010 = $2.966 billion
    • Net income 2011 = $3.650 billion
    • Net income 2012 = $2.144 billion
    • Net income 2013 TTM = $5.450 billion
  • Total asset growth

    • Total assets 2010 = $33.408 billion.
    • Total assets 2011 = $34.760 billion.
    • Total assets 2012 = $40.013 billion.
    • Total assets 2013 TTM = $35.285 billion.
  • ROA - Return on assets

    • Return on assets 2010 = 8.88%.
    • Return on assets 2011 = 10.50%
    • Return on assets 2012 = 5.36%.
    • Return on assets 2013 TTM = 15.45%

Over the past three years Visa's ROA has increased from 8.88% in 2010 to 15.45% in 2013 TTM. This indicates that the company is generating significantly more income on its assets than it did in 2010.

ROE - Return on Equity = Net Income / Shareholders' Equity

As shareholders' equity is measured as a firm's total assets minus its total liabilities, ROE reveals the amount of net income returned as a percentage of shareholders' equity. The return on equity measures a company's profitability by revealing how much profit it generates with the amount shareholders have invested.

  • 2010 - $2.966 billion / $25.011 billion = 11.85%
  • 2011 - $3.650 billion / $26.437 billion = 13.81%
  • 2012 - $2.144 billion / $27.630 billion = 7.76%
  • 2013 TTM - $5.450 billion / $27.003 billion = 20.18%

Much like the ROA, the ROE is showing increasing profitability. Since 2010 the ROE has increased from 11.85% to 20.18%. As the ROE has increased over the past four years, this reveals that there has been an increase in how much profit has been generated compared to the amount that shareholders have invested, thus indicating an increase in shareholder value.

V Return on Equity Chart

V Return on Equity data by YCharts

Quality Of Earnings

Quality of earnings is the amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory. To ensure there are no artificial profits being processed, the operating cash flow must exceed the net income.

2010

  • Operating income 2010 = $6.236 billion
  • Net income 2010 = $2.966 billion

2011

  • Operating income 2011 = $7.272 billion
  • Net income 2011 = $3.650 billion

2012

  • Operating income 2012 = $4.279 billion
  • Net income 2012 = $2.144 billion

2013 TTM

  • Operating income 2013 TTM = $9.371 billion
  • Net income 2013 TTM = $5.450 billion

Over the past three and a half years, the operating income has been higher than the net income in all years. This indicates that Visa is not artificially creating profits by accounting anomalies such as inflation of inventory.

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total assets

    • Total assets 2010 = $33.408 billion.
    • Total assets 2011 = $34.760 billion.
    • Total assets 2012 = $40.013 billion.
    • Total assets 2013 TTM = $35.285 billion.
    • Equals an increase of $1.877 billion
  • Total liabilities

    • Total liabilities 2010 = $8.397 billion.
    • Total liabilities 2011 = $8.323 billion.
    • Total liabilities 2012 = $12.383 billion.
    • Total liabilities 2013 TTM = $8.282 billion.
    • Equals an increase of $115 million

Over the past three and a half years, Visa's total assets have increased by $1.877 billion, while the total liabilities have increased by $115 million. This indicates that the company's assets have increased more than the liabilities thus adding shareholder value.

Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current assets / Current liabilities

  • Current assets

    • Current assets 2010 = $8.734 billion
    • Current assets 2011 = $9.190 billion.
    • Current assets 2012 = $11.786 billion
    • Current assets 2013 TTM = $6.941 billion
  • Current liabilities

    • Current liabilities 2010 = $3.498 billion
    • Current liabilities 2011 = $3.451 billion
    • Current liabilities 2012 = $7.954 billion
    • Current liabilities 2013 TTM = $3.671 billion
  • Current ratio 2010 = 2.50
  • Current ratio 2011 = 2.66
  • Current ratio 2012 = 1.48
  • Current ratio 2013 TTM = 1.89

Over the past three and a half years, Visa's current ratio has been decreasing. As the most recent current ratio above 1, this indicates that Visa would be able to pay off its obligations if they came due at this point.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross Margin: Gross Income/Sales

The Gross Profit Margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross margin 2010 = $6.418 billion / $8.065 billion = 79.75%.
  • Gross margin 2011 = $7.372 billion / $9.188 billion = 80.24%.
  • Gross margin 2012 = $8.281 billion / $10.421 billion = 79.46%.
  • Gross margin 2013 TTM = $9.175 billion / $11.554 billion = 79.41%.

Over the past three and a half years, Visa's gross margin has remained relatively consistent. The ratio has remained around the 79% to 80% mark. As this is an excellent margin it indicates the company is extremely efficient.

V Gross Profit Margin Quarterly Chart

V Gross Profit Margin Quarterly data by YCharts

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth

    • Revenue 2010 = $8.065 billion
    • Revenue 2011 = $9.188 billion
    • Revenue 2012 = $10.421 billion
    • Revenue 2013 TTM = $11.554 billion
    • Equals an increase of 43.26%.
  • Total Asset growth

    • Total assets 2010 = $33.408 billion.
    • Total assets 2011 = $34.760 billion.
    • Total assets 2012 = $40.013 billion.
    • Total assets 2013 TTM = $35.285 billion.
    • Equals an increase of 5.62%.

Over the past three and a half years the revenue growth has increased by 43.26% while the assets have increased by 5.62%. This is an indication that the company from a percentage point of view has been more efficient at generating revenue.

Based on the information above we can see that Visa has produced very strong results from a fundamental point of view. Even though there was a significant dip in the company's fundamentals in 2012 due to the Durbin amendment, the company has made adaptations and brought the fundamentals back to a positive trend. Revenues over the past three and a half years, have increased by 43.26%, the ROA and ROE have both signified an increase in profitability, while the increase in assets has significantly outnumbered the increase in liabilities. Based on the results above we can see that the company has produced exceptional results in spite of some setbacks.

Catalysts for Growth

Looking forward, Visa has many opportunities for growth in the emerging markets. Visa's goal by 2015 is to achieve more than 50 percent of their global revenue from international markets. Currently, Visa is focusing their growth in China, India, Brazil, Russia, Japan, Mexico, and sub-Saharan Africa. Of these markets Visa for sees strong potential in Russia, where over 80% of Russian transactions are still cash based.

In India, the global network and lack of competition will present great opportunities for Visa. Even if Mastercard Inc. (MA) and Visa split market share, it is estimated that Visa can still generate $200 billion in GDV by 2020. As Visa expands and begins to generate revenue from international markets, this will quickly drive earnings and eventually the stock price up.

Valuations

In the section below, I will use a couple of different methods to find a valuation of the stock price. In this section, I will use the Discounted Cash Flow valuation model and forward P/E ratios to estimate the current value of each share.

I believe using the Discounted Cash Flow valuation model for Visa to be fair because DCF analysis can help one see where the company's value is coming from and one can generate an opinion based on that.

(click to enlarge)

Even though there are variations in calculating this formula, this model is based off of a terminal value of $179.325B and a WACC of 5.52%. The terminal value $179.325B is based off of the company trading at 15X EBITDA. I believe this to be a fair estimation as currently the company is trading at 64.62X EBITDA. Using these valuations, I have concluded Visa's value to be $208.16 per share.

In another method, I will use Visa's forward P/E ratios with estimated earnings to find the value. Currently, Visa has a forward P/E of 20.92 and FY 2015 earnings projected at $10.44. These two metrics lead to a target price of $218.40. I believe this to be a fair P/E ratio moving forward. As we look to be heading into a rising interest rate environment, P/E ratios tend to drop during this time. Even if I took 7% off an already low forward P/E of 20.92 this would give the company a forward P/E of 19.46. A forward P/E of 19.46 would give the company a value of $203.16 per share.

As of September 12th, Visa's stock was trading at $186.31 - Using the Discount Cash Flow Formula, this indicates the stock is trading at a 11.73% discount to today's price. If I calculate a valuation using forward P/E ratios this indicates a valuation $218.40 or a discount of 17.22%.

Strategy

At this point in the market, I believe if you added a 50% position here and waited for "bad news" or the overall market to bring the price down, this would present and excellent opportunity to add positions in a company with excellent growth prospects and a great business model.

Conclusion

Even though Visa's stock price has increased from $150.00 to its present price of $186.31 over the past 9 months, I believe the stock has significant upside from here. With Visa's strong presence in North America and the company's focus on expanding its presence in emerging markets, I believe this is an excellent time to purchase the stock. At current levels using the Discount Cash Flow Formula, I have calculated that Visa is currently trading at a 11.73% discount to today's price.

Source: Visa: Undervalued With Significant Growth Ahead