Visa - Dollar Strength And International Tensions Will Have An Impact In The Final Quarter

Jul.25.14 | About: Visa Inc. (V)

Summary

Visa posts solid third-quarter earnings, in line with expectations.

The company turns more cautious for the final quarter, driven by international uncertainty and dollar strength.

Premium valuation leaves little appeal despite solid growth; I worry about long-term technological changes undercutting its business model somehow.

Visa (NYSE:V) reported its third-quarter results on Thursday after the close. The earnings report drew additional interest from investors hoping to get a clue about the impact from the tensions between Russia and the West, as well as turmoil in the Middle East.

For the year, Visa is now more cautious in terms of revenue growth, which implies some weakness for the final quarter, amidst a stronger dollar and international uncertainty. That is not necessarily the reason why I am cautious on Visa. I have concerns on the premium valuation and the worries about technological changes undercutting Visa's business model.

Highlights For The Quarter

For the past third quarter, Visa reported sales of $3.155 billion, which was a 5.1% increase from last year. Revenues were in line with consensus estimates.

The company remains incredibly profitable, as it posted net earnings of $1.36 billion, an 11.0% improvement from last year. This resulted in incredible after-tax margins of 43.1% of sales.

Reported earnings for common shares improved by nearly 15% to $2.17 per share as a result. Consensus estimates for earnings stood at $2.10 per share.

Looking Into The Quarter

Overall, revenue growth was seeing a slowdown compared to the growth pace earlier this year. The 5% reported growth was weaker on an operational basis, while currency movements impacted topline sales by another 2%.

Among the main reasons for the slowdown is the slowdown in international transaction revenues, which rose by just 0.7% on an annual basis, versus 5.3% growth so far this year.

Another diluting effect was the increase in client incentives, which rose by more than 22% to $638 million. Growth at the main service business was solid at 9.2% to $1.42 billion. Data processing proceeds managed to improve to 10.9% to $1.32 billion.

The strong earnings growth is the result of the very strong operational cost discipline. Despite topline sales growth, operating earnings were actually down by 3.2% to $1.13 billion. Cost control was demonstrated among all sub-categories.

Visa's branded credit and debit cards remain in demand and were used to facilitate $1,843 billion in transactions, which was up 6.0% as reported, but up 9.9% in constant currencies. In total, its cards facilitated nearly 25 billion in cash and payment transactions!

2014 Outlook Update

For 2014, Visa expects sales to be up by 9 to 10% compared to last year, despite having a 2% headwind from foreign currencies. This would imply that sales could approach $12.9 billion for the year.

This guidance is a 1% reduction in anticipated sales growth which the company was expecting previously.

As such, diluted earnings per share are seen up by 17.5%-18.5% compared to 2013's annual results. This implies that earnings are foreseen around $10 per share.

Visa's Valuation

The payment company ended the quarter with $2.06 billion in cash and equivalents excluding any restricted cash. The company does not have any debt outstanding, resulting in a comfortable net cash position. Including investment securities for sale, the total cash and equivalents position was about $6.8 billion.

On a trailing basis, Visa posted sales which are approaching the $12.5-billion mark. Earnings have surpassed the $5.5 billion mark now on a trailing basis.

Given that Visa posted diluted earnings of $2.17 on reported earnings of $1.36 billion, the company has about 626 million shares outstanding. With those shares trading around $215 per share in after-hours trading, this implies that equity is valued at around $135 billion.

As such, Visa trades at about 10-11 times sales and 24-25 times annual earnings. On a forward basis, shares trade at roughly 21-22 times earnings.

Benefiting From Globalization And Non-Cash Payments

Like few other firms, payment processors like Visa have benefited from globalization and the shift away from cash payments towards debit and credit cards.

As such, Visa has roughly five-folded its sales from $2.5 billion in 2004 to roughly $12.5 billion on a trailing basis at the moment. Margins have been continuously on the increase and have risen to 40%-50% on an after-tax basis, similar margins as reported by some of the most prominent biotechnology and software companies.

The company went public in 2008 at $44 per share. The offering has been hugely successful, with shares steadily increasing to levels around $215 at the moment, partially driven by consistent share repurchases, which has resulted in a 15%-20% reduction of the company's share base. Of course, Visa has consistently grown its business in the meantime.

Final Takeaway

Visa continues to grow rapidly, driven by, of course, the growth in the global economy, as well as a shift from cash payments towards cards. All of this is occurring in a rapidly changing environment, in which Visa has to navigate including increased regulation, technological change, a migration to mobile, and start-up competition.

To succeed in this environment, Visa has and will focus on innovation, partnerships and the true focus on its customers in order to benefit from the continued trends of global growth and a shift towards card payments. Yet, this very much global exposure, with 60% of volumes being done overseas, is limiting short-term growth. These headwinds are the result of a stronger dollar, uncertainty in Russia & the Middle-East, as well as inflation and violent currency movements in Latin America.

Previous sanctions made in Russia are costlier to operate, especially when officials demanded huge collateral being posted, which would be something which Visa would be very reluctant to do. The company revealed that roughly 2% of its sales are generated in that country.

While Visa is very likely to continue to outpace general economic growth by a factor of 2-3, given the outlined trends above, I am worried a bit, notably due to changing technological circumstances, which could mean new and emerging competitors for Visa and also MasterCard (NYSE:MA).

While the valuation remains a bit expensive, despite the strong track record of growth, I am notably worried about potential technological developments which could "undercut" Visa's business model.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.