Why Visa Could Be Relatively Overvalued

Aug.20.14 | About: Visa Inc. (V)


Visa is the focus of this article, with the company’s profitability, growth potential and income prospects discussed.

We also compare it to a key sub-industry peer and find that it could be relatively overvalued.

As such, we think that Visa could underperform its rival going forward.

In this article, we're focusing on Visa (NYSE:V) and assessing its strengths and weaknesses relative to MasterCard (NYSE:MA). We're comparing the two companies because they are similar in size, with Visa having a market cap of $135 billion and MasterCard having a market cap of $88 billion. The two companies also offer very similar services and sit in the same GICS sector of information technology, as well as the same GICS sub-industry of internet software and services. We hope you find the article useful, since we know many investors apportion their capital based on GICS sectors and GICS sub-industries, and we welcome your comments and views!

Growth Prospects

With the US economy continuing to make slow but steady progress, we're pleased to see that Visa is also starting to make improvements with its earnings growth rate. Indeed, Visa's fortunes are very closely tied to those of the US economy due to it being a cyclical play, so the fact that its forecast growth rate shows an improvement between this year and next year is encouraging. EPS growth in the current year to September 2014 is due to be 6.4%, while in the year to September 2015, this figure is expected to rise to 15.2%.

Despite this, Visa doesn't seem to be able to keep up with MasterCard. That's because its smaller sub-industry peer is forecast to increase EPS by a highly impressive 12.4% in the current year to December 2014, with the growth rate expected to rise to 19.7% in the year to December 2015. So, while we're very impressed with Visa's forecasts, they're currently only good enough for second place when compared to the equivalent figures for MasterCard.


It's a similar story when it comes to profitability. We're very impressed with Visa, but even more impressed with MasterCard! So, while return on equity of 20.5% is very strong - especially when you consider that Visa has no debt on its balance sheet - it is not as high as MasterCard's equivalent number of 49.5%. Sure, MasterCard runs some financial leverage, with its debt to equity ratio being 24%. However, since MasterCard's debt levels are actually fairly low we think that they are likely to only make a limited amount of difference to return on equity, which enhances our view that MasterCard's figure is the better.

Indeed, it's a similar story when looking at return on assets, with Visa making good use of its asset base with a return on assets number of 13.3%. However, MasterCard again pips its larger rival with return on assets of 23.4%, which shows that it is able to squeeze more efficiency and more profit out of its total assets. That's not to say that Visa isn't hugely profitable - it certainly is. It's just that its numbers are very much second-best when pitched against its sub-industry peer, MasterCard.

Income Potential

Despite both companies yielding less than 1% (Visa's forward yield is 0.8% and MasterCard's is just 0.6%), they both have the potential to be at least reasonable income stocks. That's because their payout ratios are incredibly low at 18% for Visa and just 12% for MasterCard. Sure, we appreciate that both companies need to reinvest within their businesses to keep their products slick and relevant. However, we also feel that they could be more generous when it comes to shareholder payouts going forward. Although neither stock is an attractive income play right now, they both have the potential to push north of a 2% yield even with an only moderate overall payout ratio.


Given that its growth forecasts and profitability are some way behind those of MasterCard, we expected Visa to trade at a significant discount to its sub-industry peer. However, Visa's forward P/E is just 1.9% below that of MasterCard at 20.8 versus 21.2 for MasterCard. Furthermore, Visa's EV/EBITDA ratio is slightly above that of MasterCard at 16 versus 15.9 for MasterCard. This surprises us somewhat, since we feel that Visa should trade at a sizeable discount to its rival. As a result, we feel that Visa may be mispriced and could, therefore, underperform its sub-industry peer going forward.

A Third Option?

Of course, we recently took a closer look at American Express (NYSE:AXP) alongside Visa and found that Visa was the more preferable of the two companies. While we were impressed with Amex's profitability, we were concerned about its debt levels, since the company has a debt to equity ratio of 285%. Furthermore, we felt that American Express had growth forecasts that were rather pedestrian in comparison to Visa, which made us feel that the company could struggle to justify its PEG ratio of 2. As a result, we felt that Visa could outperform American Express going forward.


Although we're impressed with Visa's profitability and growth potential, we are of the view that it is very much second-best when compared to MasterCard. Indeed, Visa's return on equity and return on assets, although impressive, are significantly lower than those of MasterCard. Furthermore, Visa's earnings growth forecasts, while showing signs of improvement as the US economy continues to pick up pace, are also much less than those penciled in for MasterCard.

As a result, we were surprised to see that Visa does not trade at a discount when it comes to the EV/EBITDA ratio and only trades at a small discount based on the forward P/E ratio. Due to this, we think that Visa may be overvalued relative to MasterCard. Of course, we stand by our view that Visa is a better option than American Express right now, but also believe that it will underperform MasterCard moving forward, as the market reacts to what appears to be a mispricing going forward.

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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.