Analyzing The Wal-Mart/Visa Conflict - Bezek's Daily Briefing

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Includes: EWJ, GLD, MA, SPY, V, WMT
by: Ian Bezek

Summary

Brexit volatility continues; stocks remain unsettled.

Don't expect any resolution until the vote, the polls can mislead.

Wal-Mart and Visa go to war in Canada. Why this will help Wal-Mart.

Monday saw stocks initially spike around the globe. New polling showed the forces in favor of Brexit losing ground, causing enthusiasm for equities around the globe.

US markets opened with gusto, the Dow (NYSEARCA:DIA) rose almost 300 points at the open, and the S&P 500 (NYSEARCA:SPY) briefly touched the 2,100 mark again. Additionally, a fall in the US dollar (NYSEARCA:UUP) sparked renewed enthusiasm in the commodity arena. Oil (NYSEARCA:USO) led the way, topping $50 again after last week's slump.

But by the end of Monday's session, the initial rally had been met with a persistent bit of selling. The S&P closed up just 0.6% after being up almost three times that. The Dow and Nasdaq (NASDAQ:QQQ) both gave back half their gains as well.

However, stocks have regained their footing, Japan (NYSEARCA:EWJ) surged to more than a 2% gain Tuesday, and as of this writing, European shares are also nicely higher. US stocks will open Tuesday with decent gains.

Until we're clear of Brexit, this sort of back and forth volatility is likely to continue. I've been long skeptical of Brexit's passage, and took advantage of the recent weakness in British shares to greatly upsize my position in Astrazeneca (NYSE:AZN).

That said, I trust the betting markets more than ephemeral changes in the polls. PredictIt, one such market, showed Brexit's odds of success in the low 40% range late last week. This dipped to 25% yesterday, and has recovered to 30% today.

Thus, any notion that Brexit was "likely" prior to the weekend or is "virtually impossible" now would be hyperbole. Brexit has had, and continues to have somewhere between a 1 in 4 and 2 in 5 chance of happening. The drop in stocks last week and rebound rally yesterday were both arguably excessive. Brexit was never likely to occur. However, the new polls have far from closed the book on the matter; it retains a plausible chance of passage even today. Don't let the pre-event volatility lead you astray.

While stocks appear to be heading higher on Tuesday, I'd be cautious to chase the trade. Oil has resumed moved lower, down 2% Tuesday morning to mark a quick rejection of the $50 mark. Additionally, the dollar has firmed up after yesterday's weakness. The Euro (NYSEARCA:FXE) is sliding back under 1.13 this morning.

One thing not faring well with the Brexit volatility has been gold (NYSEARCA:GLD). Gold attempted to make a new high. It briefly pushed over $1,300, hitting $1,320/oz and making an apparent breakout. It failed to close up there though, and quickly fell back under $1,300. This morning, it has fallen further, and now sits back at about $1,275.

Notably, silver (NYSEARCA:SLV) failed to regain the $18 level that it hit at the beginning of May, and it now slides back to $17.25. As long as precious metal demand doesn't increase in India and China and the US dollar remains well-bid, it's hard to see much of a case for an extended breakout in the precious metals. Brexit has preoccupied the market, but it's unclear how it'd meaningfully effect the gold market in the longer term.

Visa and Wal-Mart Canada Get Into It

If you haven't seen it, I recommend fellow SA author Robert Bezede's article: Wal-Mart Declares War On Visa And Investors Should Be Worried. In it, Bezede describes the potential fall-out for Visa (NYSE:V) and Wal-Mart (NYSE:WMT) following the recent dispute over fees between the two firms.

Wal-Mart Canada is complaining about the high fees Visa is charging it on transactions. Canada's minimum swipe fee of 1.5% is several multiples higher of the rate charged in other jurisdictions including Australia and Europe.

After negotiating, Wal-Mart Canada concluded that Visa wasn't willing to offer a rate that it felt was fair. As a result, Wal-Mart will stop accepting Visa cards at all its Canadian stores; the change will come into effect as early as July 18th and be deployed gradually on a store-by-store basis.

Bezede's article goes on to lay out the issue at great length. What I want to discuss is the risks and rewards of this standoff for both firms.

For Wal-Mart, the upside is clear. The company earns a 5% operating margin and 3% net margin. Despite Wal-Mart's unmatched ability to contain costs and pressure suppliers, it still ultimately takes home three cents of profit on every dollar of product it sells.

I don't know Wal-Mart Canada's margins specifically, but let's assume they are close to the company's as a whole. In this case, theoretically Wal-Mart Canada makes 4 cents per dollar in profit on every transaction. On a purchase made with cash, they get to keep that 4 cents. On a Visa transaction, they fork over about 1.5 cents per dollar to Visa and only get to keep 2.5 cents. This is greatly simplified, but it still makes a clear point - Visa is eating a tremendous portion of Wal-Mart's margin.

Wal-Mart has a great deal at stake by trying to force swipe fees to 1% or less and keeping them there. Expect them to take a very hard line against Visa to get their way.

From Visa's perspective, Canada alone isn't a huge concern. They can give up a significant chunk of fees there without significantly impacting their overall revenue picture. However, if Visa is forced to cave, it shows that Wal-Mart has more bargaining power, and make no mistake, Wal-Mart is likely to try to get better bargains in other geographies as well.

Wal-Mart, according to 2015 Euromonitor data, controls 69% of the Canadian hypermarket share, a figure that continues to grow. It would be hard for Visa to legitimately claim to be Canada's leading credit card network if they are locked of Wal-Mart. MasterCard (NYSE:MA) has a nice opportunity with the Wal-Mart Rewards MasterCard in Canada if the current standoff continues.

As a shareholder in Wal-Mart, I enjoy seeing them get into these sorts of tussles. The Walton spirit than made the firm so successful clearly lives on. When Visa caves - I firmly expect them to - it will be another clear victory for Wal-Mart at the hands of a large and powerful foe.

Remember also that Wal-Mart has a lot of experience with financial services, it has offered banking and other such products in various geographies. There's lot of talk of the threat to Visa and MasterCard from new fintech players such as PayPal (NASDAQ:PYPL) and Square (NYSE:SQ). And with good reason. But sometimes threats come from older behemoths; I for one am watching Wal-Mart's actions closely.

Disclosure: I am/we are long WMT, AZN.

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.