Visa (V) is the leader in the U.S. credit cards market, and we believe that it will continue to lead the market due to its resolve to provide innovative payment options to its clients. The secular shift toward electronic payments will contribute further to its growth. However, headwinds from unfavorable activities in the U.S. aggregate payment volume, combined with litigation issues, will partially offset the growth. We still believe the company has the financial muscle to embark upon opportunities that come its way (particularly Near Field Technology), which is why we maintain our buy rating for Visa.
American Express (AXP)
Discover Financial Services (DFS)
Master Card (MA)
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Visa operates in more than 200 countries and territories, connecting governments, financial institutions, businesses, and consumers, to provide access to secure and reliable global payments using digital currency instead of checks and cash. The San Francisco-based company does not issue debit or credit cards, or set fees and rates for customers. It primarily earns fees from financial institutions that utilize its network. The products that it offers include Credit, Debit, Prepaid and Commercial. For the purpose of reporting, the company is organized into four segments; Services Revenues, Data Processing Revenues, International Transaction Revenues and Other Revenues.
The company's revenues are highly reliant on the kind of innovation that the company has to offer to its financial institution clients. More payment choices offered by Visa means more choices offered by financial institutes, and the resultant increased fees that Visa collects on them. Currently, the company is offering Prepaid (pay ahead), Debit (pay now) and Credit (pay later) choices to its financial institute clients. Future growth in the company will depend on its ventures on the upcoming Near Field Communication (NFC), particularly the one with Samsung for the Olympics, which will allow customers to make secure payments wirelessly using their Samsung Galaxy S IIIs.
A positive secular trend toward electronic payments in recent years, especially mobile payments, is a major opportunity and a driving factor. Payments through checks are on the decline, as demonstrated by the data compiled by First Data, and reported by Bloomberg. Check payments have witnessed a decline year over year since the beginning of the year. However, payments through credit and debit cards are on the rise. Network companies that have positioned themselves to capitalize on this opportunity will witness an increase in their market share.
U.S. aggregate payments volume trend, as reported by Visa, for the month of April 2012 plunged by 3% compared with the prior year. The decrease was largely attributed to a decrease of 12% in the U.S. debit payments volume, partially offset by an 8% increase in the U.S. credit payments volume. The May 2012 aggregate payments volume remained flat compared with the prior year. A breakdown revealed an 8% decrease in the debit payments volume, while a 10% increase was witnessed in the credit payments volume.
The company is heavily involved in litigation. Visa, along with its major competitor MasterCard , and other banks, has agreed to settle a retail issue through a payment of $7.25b, where Visa's share is $4.4b. However, Visa's earnings will not be affected significantly, as it has $4.28b in the escrow account. Under the agreement, card companies have agreed to reduce their interchange fees by 10bps for eight months. This would mean less revenue for Visa in the coming quarter. The U.S. Justice Department is also investigating the company for pricing changes that it implemented while responding to new regulations regarding debit cards.
The company presented strong results when it reported its second-quarter earnings this year. The company earned a net income of $1.1b on revenue of $2.6b. Both revenue and net income were up by 15% and 23% compared with the previous year. The improvement in results was largely attributed to a continued positive secular shift and spending momentum. Revenue from the Services segment was the largest contributor, however, International Transaction revenue witnessed the largest increase of 17% YoY.
A 15% increase in net operating was partially offset by a 13% increase in operating expenses, resulting in zero operating margin growth compared with the same quarter last year.
Balance Sheet Strength and Valuations
The company has no debts, while it has $2.46b of levered free cash at hand. Since the company has no debt servicing, and pays only $300mn in dividends, the company seems to be in a position to capitalize on opportunities that come its way.
The stock, with regards to its price-to-earnings ratio, is trading in line with its industry peers. However, its price-to-book value multiple is trading at a discount of 17% compared with its competition. Using a price-to-earnings multiple of 22x, and 2014 earnings estimate of $8, with an upside of 37%, we reach our target price of $176.
The company has witnessed tremendous growth (30%) over the past five years. With a P/E to growth ratio of 1, analysts estimate the company will grow by 19% over the next five years.