Visa (NYSE:V) is a leading global technology company that connects consumers, merchants, banks, and governments with the use of its global electronic payment network. Visa's primary revenue stream comes from personal consumption expenditures. In the past five years, Visa was able to grow revenues at a double-digit rate, although global personal consumption expenditures only grew at approximately 3% per year. This phenomena can be explained by the rise in the conversion of cash to electronic forms of payments. This paper will cover the following:
- How Visa's strategic initiatives regarding digitalization and card penetration can increase its competitive advantage;
- Growth opportunities in the developing world using its various platforms;
- Analyze Visa's financial performance in the 2016 fiscal year;
- Evaluate Visa's intrinsic value using absolute and relative valuation models;
Visa's strategic initiatives regarding digitalization and card penetration can increase its competitive advantage
Visa expanded its innovation labs beyond its headquarters in San Francisco. The company opened innovation centers in various locations around the world including Singapore, Dubai, Miami, and it plans to launch additional locations in New York and Sao Paolo. According to the CFO, Vasant Parbhu, these new labs will help Visa develop new digital channels that will result in the safest, most reliable, and most secure network possible. Digitalization through technological innovation can contribute to Visa's competitive advantage, and with $5.1 billion in free cash flow, management has the resources needed to sustain constant investments in new technologies through acquisitions or internal developments. Some of the digital channels that the company rolled out in recent years are Visa Checkout, Visa Ad Measurement, Visa Direct, and mVisa. Mass adoption of these channels by merchants and consumers will correspond to a greater competitive advantage and wider economic moat from the already dominant position that Visa has in the industry (62% market share in transaction volume).
On October 2016, Visa rolled out a redesigned Visa Checkout experience that is more mobile focused. This technology is crucial in the new era of virtual wallets since it allows Visa to have a presence at the point of acceptance when a transaction takes place. Visa Checkout gives consumers the opportunity to integrate its digital wallets into the Visa network, and enjoy a frictionless shopping experience with enhanced security features. These benefits correspond with greater supplier power and customer switching cost, but Visa faces the same problems as other industry participants when it comes to digital wallets. The main issue is the slow adoption of digital wallets by consumers, which is a result of growing fears of cyber identity theft, and lack of education regarding the technology. Visa builds strategic partnerships with various companies, such as Apple, Google, and PayPal, to educate the public about the technology. Visa also leverages its brand recognition, superior technology, size, and experience to gain market share in the digital wallet space with the Visa Checkout application. Visa Checkout ended the 2016 fiscal year with over 15 million consumer accounts in 21 countries. Over 300,000 merchants have signed on to accept Visa Checkout, which can potentially add $162 billion in transaction volume to the company. This is a 2% increase from the $8,119 billion in transaction volume Visa had in 2016.
Visa Advertising Solutions (Visa Ad)
In September, Visa introduced a new suite of services called Visa Advertising Solutions. This new service helps merchants reach new customers by optimizing their advertising. Visa Ad provides analytical information based on transaction data from the Visa network. The information expected to help merchants better understand their customer demographics and purchasing decisions. Transaction data is probably one of the most valuable assets in the growing e-commerce market, and Visa has a front seat to such data. In the earning call, management expressed its willingness to use transaction data more efficiently to improve its eco-system. Visa has a significant advantage regarding transaction data over its competitors (MasterCard Incorporated (NYSE:MA) and American Express Company (NYSE:AXP)) since 62% of the total electronic payments in the world goes through its network. In my view, this complementing service has the potential to become a long-term force that enhances Visa's competitive advantage for the following reasons:
- It will help build relationships that extend beyond just processing transactions;
- It will increase merchants' dependence on the Visa network, which will correspond with increased customer switching cost and supplier power;
- It can provide another source of revenues;
- The service can be integrated as part of the incentive plan for large merchants, such as Costco;
- Better understanding of customer demographics by merchants will lead to better marketing, and higher sales volume that potentially will correspond with increased transaction processing volume within the Visa network;
The only risk that the company faces with such service is the violation of privacy laws. It is a challenge to provide a global product, but at the same time comply with the various privacy laws around the world. As Spiderman's uncle used to say, "with great power comes great responsibility," and Visa should act with care when using its robust network to collect and distribute such private transaction data.
Visa Direct (Push Technology)
Push technologies that enable fast payment from person-to-person without the need to link the transaction to personal bank accounts continue to be an opportunity around the world. Visa Direct is a value-adding push technology that provides an opportunity to transfer money from P2P, B2B, or P2B. It is similar to a wire transaction, but unlike a wire transaction, the transfer does not need to be exclusively linked to your bank account. The benefits of the Visa Direct include:
- Enhanced security through superior framework of risk and controls that reduce fraudulent activities;
- Cost efficiency;
- Speed of the transaction (within 30 minutes it in the account);
The scaling potential of this platform is tremendous because it provides merchants, governmental entities, and corporations an opportunity to push payments to Visa accounts instead of sending checks in the mail, which is not only less secure but also slower and more expensive. Such payments can be tax refunds, insurance claims, rebates, contractor payouts, or expense reimbursements.
Growth Opportunities in the Developing World
In the earning call, soon to depart CEO, Charlie Scharf, mentioned that Visa Push technology would help the company penetrate new developing economies where people have access to smart mobile phones, but lack access to traditional banking services. Visa recently launched the mVisa service, which ultimately has the same technological functionality as Visa Direct, to solve those problems in India, Kenya, and Rwanda. The company is planning to expand the mVisa service to other emerging markets around the world during 2017 but didn't mention specific locations. mVisa allows consumers to transfer money to merchants in real-time with using only their mobile phone, and merchants to accept Visa transactions immediately without any additional hardware. The opportunity Visa has in those developing markets is tremendous because those markets are primary drivers of global growth in the electronic payment industry. According to the world payment report, non-cash transaction in the developing markets grew by 16.7% in 2015, and now represents 29.1% of the global non-cash transactions. India is the perfect example for the potential mVisa has in those developing markets from regulatory and economic perspective. Some highlights of why India is such a great opportunity for the mVisa platform:
- Recently, the Indian government announced that it would ban the 500 and 1,000 rupee bills (approximately 80% of the currency in circulation in India) to fight money laundering, corruption, and other black market activities;
- Today approximately 90% of the people in India still use cash to facilitate transactions, and according to the Hindu only 53% of the population has a bank account;
- India has over one billion cell phone users, and one of fastest growing internet access in the developing world, even in the most rural parts of the country;
- According to the Economic Times, e-commerce in India is expected to grow to $1 trillion by 2020;
Fiscal Year 2016 Financial Performance (10-K)
On a GAAP basis Visa closed the year with EPS of $2.48, but for analysis and comparison purposes, I decided to exclude two one-time items, which are a one-time $110 million charge, severance cost, and an $88 million non-cash gain related to the re-measurement of deferred tax liability. Excluding those items, net income for the full year was $6.9 billion, and EPS $2.84, which is a 10% increase from the $2.58 EPS in 2015. Net revenue increased by 8.6% to $15.08 billion on a comparable basis ($13.88 billion in 2015). When we break down revenues, it is hard to miss that client's incentive expenses increased by 19% YOY, and now represents 18.5% of gross revenues (versus 17% in 2015).
In the earning call, management mentioned that for 2017 they expect client incentives to represent 20%-21% of gross revenues. According to management, there are two main reasons for the increase. The first is the acquisition of Visa Europe, and the implementation of performance-based client incentives for the European segment instead of rebates. The performance-based incentives create a correlation between the incentives given to the client and the client's performance, which means that incentives and revenues will be moving proportionally up or down. From an economic perspective, it can be positive because gross margins in the European segment will expand if revenues are growing. The second explanation that management provided for the projected incentives increase in 2017 relates to the broad multi-year renewal agreements with its major strategic partners, such as RBS, Lloyds Banking Group, Barclays, BBVA Bancomer Mexico, China CITIC Bank, Russian Alfa-Bank.
Operating income (EBIT) on a GAAP basis declined to $7,883 million, which is a 13% decrease from 2015. The decrease in operating income is in line with the drop in earnings on a GAAP basis (earnings were $5,991 in 2016 vs. $6,313 in 2015), which means that the risk of earnings manipulation is low. On a GAAP basis operating margins (EBIT) came in at 52.27%, which is lower than the five-year average of 53.1%. For comparison purposes, if we exclude the one-time operating expense related to the acquisition of Visa Europe, operating income for the fiscal year 2016 will be $9,760 million, which is a 7.6% increase from 2015. The adjustment leads to an operating margin of 64.7%, which is still lower than the 65.3% in 2015, but greater than Visa's five-year average operating margin. Management expects operating margins to be in the mid 60% in 2017, and this seems to be a very realistic assumption when taking into account the integration of Visa Europe.
On a GAAP basis ROE (Earnings/Average Equity) was 21% in 2016, which is slightly lower than the 22% in 2015, but in line with the five-year average (excluding the litigation expense in 2012). ROA (Earnings/ Average Assets) was 11.5% in 2016, which is lower than the 16.06% in 2015. The decline in ROA was due to the issuance of $15 billion in debt that was used for the Visa Europe acquisition. The issuance of debt also led to a higher financial leverage (Average Assets/ Average Equity), which now stands at 2.35x. The company plans to issue another two billion of debt in 2017 if market conditions are appropriate.
Visa continues to grow its dividend payments to shareholders, and currently, it pays $0.66 per share on an annual basis. The current dividend represents a 32% increase from the $0.50 dividend per share in 2015. Based on the current dividend per share, and the dividend growth trend for the past five years, I decided to use the three-stage dividend discount model for my absolute valuation. The following assumptions were used to determine the intrinsic value of the stock:
- 20% dividend growth rate for the accelerated growth phase for the next three years;
- The second growth phase will last for two years at a rate of 14%;
- The terminal value growth rate will stabilize at 8%;
- Required return of 9.1% (based on an adjusted beta of 1.10 (current beta 1.16*(2/3) +(1/3)), equity risk premium of 6%, and risk-free rate of 2.5%);
Based on those assumptions the intrinsic value per share is $98.57, which is a 24% upside from the current price of $79.3 (as of 11/28/16).
From a relative valuation perspective, the P/E multiple is currently at 31.24x (as of 11/28/16), which is in line with the five-year average P/E of 31.71x. On the other hand, the P/OCF is currently at 34.55x, which is slightly lower than the five-year average P/OCF of 36.41x. The P/Book is currently at 6.04x, and this is higher than the five-year average P/Book of 4.32x. Assuming earnings will grow at 10% next year, and investors will keep rewarding the stock with a high multiple of 30x earnings, the FVPS is $93.72. This is an 18.5% upside potential from its current price of $79.3 (as of 11/28/16).
Visa's executive management is investing many of its resources in technological innovation, which helps them maintain their leading position in the industry. They view those investments as access key to the growing emerging markets around the world. Visa looks like an attractive investment from both valuation perspectives, absolute and relative, and the recent pullback can be a good entry point for investors.
Disclosure: I am/we are long V.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.