While the majority of the market focuses on the global shift towards payments via credit cards, investors in Visa (NYSE:V) miss that the world is gunning for the high margins of the payment processor. Incredibly, Visa is now valued nearly equal to Bank of America (NYSE:BAC) that has a vastly larger operation.
For those that think numbers eventually even out, the scenario suggests that long-term investors buy Bank of America and short Visa. The whole world is gunning for a piece of payment services and the processing fees with absurdly high margins, while the market has limited desire to pursue the mortgage, banking accounts, and lending business of Bank of America.
Previous articles on direct competitor MasterCard (NYSE:MA) suggested earlier this year that the stocks of the credit card processors could be peaking for a couple of reasons. Now, seven months later, the stocks are sideways to down during that period after a few years of strong gains.
Can Profit Margins Last?
Looking at the below chart, one can quickly derive why it seems like the whole world is trying to get into the payment processing business. Just about every company in the wireless eco-system, from operating systems to phone makers to tons of start-ups and new digital currencies like Bitcoin, are gunning for the margins of Visa and MasterCard.
If you were building a new business in the financial sector, which business would you target? One of the main points of digital currencies like Bitcoin is to reduce or remove the costs of such transactions. Even American Express (NYSE:AXP) can't match the margins of Visa.
When reviewing the latest quarterly report, Visa had some interesting stats that question whether the stock justifies a forward PE of around 20.
- Net operating revenue increased in Q314 to $3.2 billion, up 5% over the prior year.
- Payments volume growth for Q314 was up 11% over the prior-year period to $1.2 trillion.
- Cross-border volume growth was 7% for the quarter.
- Service revenue of $1.4, an increase of 9% over the prior year.
- The company repurchased 5.6 million shares at an average price of $207.13 for $1.2 billion.
According to the above stats and chart in the previous section, Visa is in the peculiar situation of needing actual expense reductions in order to grow earnings faster than the meager revenue growth. During the quarter ended in June, Visa actually reduced operating expenses by 3% in the quarter over the prior year to $1.1 billion. With profit margins already sitting at 43%, the company doesn't have a lot of other options to meet financial targets other than letting the margins fall (not a good scenario for the stock).
Another interesting point is that the company used substantially all of the cash generated in the quarter to repurchase stock that most would suggest isn't cheap at 20x fiscal 2015 earnings. At that valuation level, the stock buyback program has a limited impact on the outstanding shares, with a YoY decline of only 23 million shares, or roughly 3.5%.
Visa is in a peculiar situation, with a large swath of companies targeting the high margins and limited actual revenue growth. Too many things have to go right for Visa to provide gains for investors at a market cap of nearly $140 billion. If anything, the most likely avenue over the long term is for the company to lose market share or lose margins. Neither option is good for a stock trading at 20x forward earnings. Investors should sell the stock.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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