Visa: Execution Near-Flawless And Brilliant Capital Allocation

| About: Visa Inc. (V)

Summary

Visa continues to operate one of the most fundamentally sound businesses on earth.

Capital allocation is an underrated aspect of the investment thesis.

V.me was a dud, but Visa Checkout has more potential.

Shares are not extremely expensive right now; but compounding intrinsic value makes Visa an ideal long-term position.

Late last week, Visa (NYSE:V) reported consensus-beating earnings for the fifth time in the past 7 quarters. As per the usual, Visa came in well in excess of consensus, earning $2.17 versus the consensus estimate of $2.09. That's not to say that I care much about what analysts think about the stock, nor do I believe "missing" or "beating" has anything to do with Visa's long-term valuation. However, I think it underscores one of the beautiful things about Visa: sustainable fixed cost leveraging. Operationally, I can't think of a company executing better than Visa. It's fair to question the company's ability to build a sustainable competitor to rival PayPal. However, I think Visa's talented management continues to brilliantly allocate capital.

Sustained Operational Excellence the Primary Growth Engine

When it comes to operations, Visa remains the undisputed king of well-run companies. Former Chase retail CEO and current Visa CEO Charlie Scharf has done a wonderful job of pushing for more co-branded cards. Scharf landed an exclusive agreement to supply cards to JPMorgan Chase's (NYSE:JPM) retail banking operations, as well as an agreement to build out an exclusive network product built on licensing Visa's VisaNet transaction processing network.

Additionally, Visa signed an exclusive partnership with Tim Horton's (THI) - Canada's largest QSR. The card acts as a duel-rewards card with easy reward redemption as well as a traditional Visa credit card backed by CIBC (NYSE:CM). While a deal like the aforementioned partnership with Tim Horton's will not move the needle by itself, it provides a template for incremental partnerships and future co-branded products in Visa's developed markets.

On the innovation front, Visa continues to invest heavily in the online payment space. Management isn't happy with CyberSource's lower growth rates, and management noted that the company continues to make additional investments to reignite growth. Ultimately, growth in this area will fluctuate, but I'm confident Visa will be able to use some of its robust free cash flow to improve the value of CyberSource.

Yet, Visa continues to struggle to create a strong competitor to PayPal (NASDAQ:EBAY). Visa launched V.me in the winter of 2011, and it never found traction in the market. I think there were a few major issues with the V.me launch. They always seemed to have a soft launch, and I think brand awareness was very low. PayPal and even upstart Venmo have achieved far more ubiquity than V.me ever mustered.

Interestingly, Visa noted that it is going to invest heavily in marketing the re-launch of V.me, which is now known as Visa Checkout. Strategic brand partnerships, an actual launch, and a high budget marketing campaign should lift the product from obscurity and break through the extremely low barriers to entry in establishing an account. With some security concerns at both eBay and PayPal, Visa Checkout will be branded as a much more secure payment network leveraging Visa's superior reputation for security standards. Yet, I think it still lacks in user interface, so I am skeptical of maintaining an active user base.

Still, I do not believe Visa is having any issue capitalizing on the global growth in e-commerce. The core in-person transaction business still has runway as consumers shift from using cash to credit-particularly in emerging markets.

Visa's Underrated Brilliant Capital Allocation and Management

When it comes to managing the company as efficiently as possible, Visa has been the anti-Apple. CFO Byron Pollitt has grown to be one of my favorite CFOs in any industry. Yes, Visa owns a structurally beautiful free cash flow machine that prevents the company from possessing much liquidity risk; however, Pollitt has not sat on his hands collecting a pile of cash. The company bought back stock extremely aggressively at favorable levels that resulted from the Durbin Amendment. As a result, the float has shrunk by 19% since 2008 with a substantial amount of that buyback coming at inexplicably cheap prices.

Investors may question why Visa remains so aggressive with its share repurchases. The board approves meaningful repurchases every year. At the end of FY13Q4, the company announced a $5 billion repurchase program. Since the inception of the program, Visa has bought back $3.28 billion worth of shares. Management does not waste time putting cash to use. The stock currently trades at 20.7x FY15 EPS and 18x FY16 EPS-so shares are not trading at a level investors generally think of as cheap. However, I think Visa understands the sustainability of its free cash flow generation and superior long-term forecasting models that identify where business is going. Thus, Visa trades at a discount to its intrinsic value that continues to grow annually. Come 2016, I think the company could be growing in intrinsic value by 17-20% per year, making Visa ripe to be a compounding machine.

In addition to continuing to aggressively allocate cash, I think Visa effectively manages its capital structure. An undisciplined management team may be tempted to take on cheap debt to boost share repurchases or dividends given Visa's cash rich business model. Yet, management is in-tune with prevailing distaste for the credit card market's robust economic profit generation. Visa is vulnerable to expensive litigation and potentially negative decision outcomes that could cost the company billions.

This allows the company to be very flexible in its cash allocation without any debt servicing expenses. I prefer the operating leverage inherent in Visa's business model to additional financial leverage.

More than anything, I love that Pollitt doesn't let Visa's cash suffer erosion from time value in the bank. With a reliable cash machine at hand, he makes sure that shareholders are getting consistent returns via buybacks and dividends.

What's Visa Worth?

I do not always like valuing enterprise in a passive sense-investors make money in great companies over the long-term because the business becomes more valuably every year-not as much from a company trading at a meaningful discount at one point in time. As I noted earlier, I see the company's intrinsic value at growing about 17-20% annually over the next five years. Currently, I think shares are worth about $260 a tad less than 25x FY15 consensus earnings. More importantly, I think shares could be worth upwards of $300 by the end of FY15. Visa isn't cheap enough to anticipate 40% returns from current levels, but I think a 21% upside cushion is a decent margin of safety for such a fantastic company with sustainable free cash flow generation capabilities.

Disclosure: The author is long V. 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.