Shares of Visa (NYSE:V) have been facing some pressure amidst a downgrade from analysts at Raymond James citing a bunch of reasons to be cautious on the shares in the periods ahead.
I share the cautious stance on the shares, but not necessarily for the same reasons. While the premium valuation might seem justified given the incredible pace of growth in recent years, I have my doubts about the medium to long term viability and future of the current business model.
Reasons To Turn Cautious
Analysts at Raymond James have downgraded their rating for Visa from Outperform to Market Perform, cutting the price target by twenty-two bucks to $213 per share.
Analyst Wayne Johnson notes a lack of business catalysts in light of the already planned buybacks. This trend of not much positive triggers could weigh on shares. Besides the lack of positive triggers, there are plenty of potential headwinds weighing on shares. Johnson has identified a total of 6 worries for the upcoming year.
1. Of course lower processing volumes in Russia could hurt earnings on the back of tensions between the "West" and the country. This effect could impact estimates by an amount to roughly $0.03 per share. Remember that Visa generates roughly $400 million in sales from Russia.
2. Other than lower Russian processing volumes, general lower cross-border volume trends could impact earnings between five and nine cents per share. This came after the company recently already warned that growth in this segment is slowing down.
3. Lower CyberSource transaction growth could hurt earnings by two pennies per share.
4. Lower domestic spending could hurt earnings by an estimated four to five cents for every percentage point of lower dollar volume growth.
5. One of the potential bigger impacts results from the renegotiation of the payment terms in general with its partners which could impact earnings by another $0.23 to $0.27 per share.
6. And finally the company has cut a lower fixed pricing deal with Chase impacting earnings as well.
All in all these items could hurt earnings to the tune of about $0.50 per share which is rather modest in light of the 2015 earnings estimate of $10.23 per share as set by Johnson.
The Recent Reading From The Third Quarter Results
At the end of July, Visa released its third quarter results. Reported revenues rose by 5.1% to $3.15 billion as the company reported solid sales leverage on the bottom line amidst tight cost control. Earnings rose by 11% to $1.36 billion, increasing its incredible fat margins even more.
The 5% sales growth is rather slow as the company's shareholders have been getting used to double digit sales growth in the past few years. It should be noted that adverse currency movement subtracted about 2 percentage points from reported sales growth.
The company cited modest cross-border transaction growth as well as a key reason behind the shortfall. The company has also been seeing some margin pressure in terms of what it can charge for its products with payments volumes increasing by 12% to $1.1 trillion.
For the full year, Visa anticipates 9-10% growth in sales in constant currencies as adverse foreign exchange movements are anticipated to subtract 2 percentage points in reported sales.
Diluted earnings for the Class A shares are seen up by 17.5% to 18.5% compared to last year.
Based on this guidance, sales for the year are anticipated at around $12.6 to $12.7 billion, as earnings are seen around $8.95 per share.
But What About The Valuation?
At the end of the quarter, Visa stressed that it had $6.8 billion in cash, equivalents and for-sale investments, while it has no debt, resulting in a very solid financial position.
With some 628 million shares outstanding at the moment, and those shares currently exchanging hands at $215 per share, equity in the business is valued at around $135 billion. This in its turn values operating assets at around $128 billion.
This values operating assets of the business at around 10 times anticipated sales and 22-23 times earnings anticipated for this year.
A Prime Beneficiary From Globalization, But What About The Future?
Between 2004 and now, Visa has roughly five-folded its annual sales from $2.5 billion to $12.5 billion, growing sales at a compounded annual growth rate of about 17%. Despite this impressive historical growth, recently reported growth is slowing down both on a percentage basis as well as the absolute incremental increases in sales.
The increased global middle class, economic growth and a shift from cash towards payments on debit and credit cards have been really beneficiary for the business.
The margins of the business have continued to increase to absurd levels with net earnings coming in at 40-50% of sales on an after-tax basis. These impressive margin gains and revenue gains have resulted in an earnings explosion which has furthermore been aided by complementary share repurchases.
Back in July, I took a look at the company's prospects following the release of its third quarter results.
I noted the strong long term tailwinds of globalization, the shift towards payments on cards and increased spending by a global middle class over the past decade. While these trends will continue to drive growth in the coming decade, risks are apparent as well in my eyes.
The very high margins attract competition with numerous businesses like Square and PayPal (NASDAQ:EBAY) being on the rise, while it cannot be ruled out that technology giants like Facebook (NASDAQ:FB) or Google (NASDAQ:GOOG) will make an entrance in the market as well.
These emerging competitors, technologies and the shift towards mobile payments can have huge implications for the business potentially. These trends and short term headwinds caused by the dollar strength and potentially $400 million in Russian revenues at risk put pressure on the short to medium term appeal.
In that light I am a bit hesitant to pay a 20% premium versus the wider market despite the very strong track record and the asset light business model. This is why I am unsure about the future of the business five or ten years down the road.
For that reason alone, I remain a bit cautious and continue to watch the action from the sidelines, sharing the relative cautiousness as displayed by Raymond James.
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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.