While economists are pessimistic about how slow the recovery has been, financials are still well positioned to take off at full employment. In my view, consumer financial services offer a terrific way to play bullishness on consumer expenditures. In this article, I will run you through my DCF model on Visa (V) and then triangulate the result with a review of the fundamentals against American Express (AXP) and Citigroup (C). I find all three of these firms meaningfully undervalued.
First, let's start with an assumption about the top-line. Visa finished FY2011 with $9.2B in revenue, which represented a 13.9% gain off of the preceding year. I model per annum growth trending from 20% to 14% over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model operating expenses at 44% of revenue versus 3.5% for capex. Taxes are estimated at 34% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital to get free cash flow. I estimate this figure netting out at around 0% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $139.92, implying 19.2% upside. The firm currently trades at 11.2x my 2017 free cash flow estimate.
All of this falls within the context of impressive 2Q12 results:
"Visa delivered another quarter of strong financial performance, posting net operating revenues of $2.6 billion, a 15% increase over the same period last year. These revenue gains were driven by double-digit payment volume growth globally, continued outperformance of credit spend worldwide and a strong cross-border activity.
Adjusted net income for the quarter was $1.1 billion, a 23% increase over the same period last year. This equates to adjusted diluted earnings per share of $1.60, a 30% increase over the second fiscal quarter of 2011".
From a multiples perspective, Visa also appears decently attractive. It trades at a respective 27.4x and 16.6x past and forward earnings. The firm is mostly a growth play due to its direct exposure to rising consumer expenditures. For more of a value investment, I recommend Amex and Citigroup. Amex currently trades at a respective 14.2x and 12.4x past and forward earnings versus 8.5x and 6.5x for Citigroup.
Consensus estimates for Citigroup's EPS forecast that it will grow by 13.6% to $4.19 in 2012 and then by 12.4% and 10.6% in the following two years. Assuming a multiple of 11x and a conservative 2013 EPS of $4.67, this stock can soar by nearly 70%. While the company is very volatile at a beta of 2.59, this allows for higher risk-adjusted returns. Over the last 6 months, the stock has been roughly flat at 5.5% appreciation while peers, like JPMorgan (JPM), have taken off. This disconnect further makes the case for a bull story as the bar has been set low despite otherwise impressive fundamentals.
Consensus estimates for Amex's EPS forecast that it will grow by 5.9% to $4.33 in 2012 and then by 10.6% and 13.2% in the following two years. Assuming a multiple of 16.5x and a conservative 2013 EPS of $4.75, the stock would hit $78.38, implying 31.9% upside. Amex customers have a stronger appeal to higher ticket items, which will cause particularly strong growth when consumer expenditures return to normalcy. In my view, management should consider boosting the divined yield in order to court risk-averse investors.
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