How Long Will Visa's Slump Last?

Summary

• Visa's stock has been in a slump since hitting highs in October. The slump is due to increased volatility, not a change in Visa's fundamentals.
• Visa remains dominant in its industry, continues to generate loads of cash, and is poised to continue growing thanks to an increasingly digital world, and strategic moves in international markets.
• The current valuation is 16% below historical norms, and free cash flow yield is near five-year highs. It's a great time to accumulate shares for a long-term investment.

Payment services and technology company Visa Inc. (NYSE:V) has been in an extended slump since the fall, which is a rarity for a stock with a sterling reputation as a growth stock (average earnings multiple of 30X over the past decade). Since hitting a high of $151 per share in October, the stock has drifted lower. In the past four months, Visa has traded as low as $121, and currently sits about 11% from its October levels at $133 per share.

Source: Ycharts

Why the decline? The answer can touch on a number of influences, but the most obvious answer is simply market volatility. A number of stressors have emerged over the past four months such as continued trade tensions with China, and the tension in Washington surrounding border wall politics. We can see in the chart below that the tension has moved the VIX higher (which measures expected market volatility), and the S&P 500 has felt the impact as well.

Source: Ycharts

Visa's high valuation (sometimes exceeding 35X earnings) resulting from its strong growth makes the stock vulnerable to both internal and external disruptions. In other words, a high valuation "sets the bar high," so even small factors - whether via the overall market (external), or Visa's business performance (internal) - can result in a price correction.

Whenever something like this happens, we as investors need to investigate whether the downward catalyst relates to the fundamentals of the business or not. To do this, we review Visa's fundamentals.

Source: Ycharts

Visa has shown a steady trend of expanding its margins and increasing its FCF conversion rate over the past decade. While operating margin has slightly dropped off over the past year or so, the levels that Visa operates at are still very strong. The ability for Visa to convert more than $0.58 of every revenue dollar into free cash flow is truly exceptional. Many companies struggle to even convert 10% of revenues into cash flow.

An added bonus of Visa's business model (functioning as a "toll booth" for payments) is that Visa is insulated from inflation. The company collects a percentage of each transaction it processes, so its revenues will rise as the cost of goods increases.

Source: Ycharts

A similar trend is evident when we look at the cash rate of return on invested capital (CROCI). This metric measures both the efficiency of management by how much cash they generate with the company's resources, and the strength of the business's competitive "moat." Visa's current CROCI of 23.76% is strong (we typically look for a rate in the low-teens), and is in an uptrend over the past decade. This is partially due to Visa's strong insulation from competitors. Visa's business operates as part of an oligopoly, where it essentially controls the payment services market along with peers Mastercard (MA), American Express (AXP), and Discover (DFS).

Source: Ycharts

With such a profitable business model, the balance sheet is in great shape as well. Visa carries enough cash on hand to account for half of its total debt ($8.16B in cash versus $16.63B in debt). The leverage ratio of 1.21X EBITDA is very manageable.

Because Visa is a capital-light business (hence the sky-high cash generation metrics), it is able to shower investors with cash in the form of stock buybacks and dividends. The company spends billions on share buybacks every year, and this has gradually shrunken the float over time.

Source: Ycharts

Meanwhile the dividend is growing at a rapid pace (CAGR of 22.8% over the past five years), and has been raised every year since the company went public. Because of Visa's growth over the years, the dividend consumes a small fraction of cash flow (just 16%), leaving immense dividend upside for years to come.

With such strong cash generation, financial strength, and output to shareholders, we see an intact investment thesis present. Given how short-sighted markets are (they have a tendency to treat stocks with a "what have you done for me this quarter?" attitude), is Visa's long track record of growth tarnishing? Is this the reason for the slide? Things continue to look strong here as well.

Visa just released its FY19 Q1 earnings, and they were solid once again. Both revenue (up 13.2% YoY) and earnings per share beat analyst estimates (EPS beat by $0.05). Visa has cleared analyst estimates regularly for years, and continues to do so. Going back to the beginning of FY14 (21 quarters), Visa has only missed revenue estimates a total of four times. Visa hasn't missed a single EPS estimate in that 21-quarter span.

Source: Visa Inc.

Its most recent quarter exhibited continued steady growth with payment volume growth at a double-digit pace of 11%.

Source: Visa Inc.

While CFO Vasant Prabhu did outline some potential headwinds that Visa is facing as they get further into 2019 (international factors that could knock a full percentage point off of revenue growth), Visa stuck by its current full year forecast.

We certainly don't see a single percentage point loss on double-digit growth as reason to change our overall grade on the stock - especially as a long-term investment. There are just too many growth drivers present for the upcoming years. Visa is the dominant US payment processor with more than 60% market share. Meanwhile, the company is establishing key relationships in international markets. It has established a co-brand relationship with Amazon (AMZN) in India, which could end up turning into one of the largest credit card groups in the country (a country that holds 1.3 billion people, and more than 90% of transactions are still done in cash).

When you look at all of the data, it becomes evident that Visa's slump is simply a result of a volatile market cooling off a stock that has mostly appreciated over a period of years. Weakness under these circumstances is a reason to buy a stock, not to avoid it.

So where does the stock stand now? The stock trades at just under $134 per share. Based on analyst projections of $5.32 for FY19, the stock currently trades at 25.18X earnings. Considering Visa's 10-year median earnings multiple of 30.08X, the current price offers a 16% discount to historical norms.

Visa's strong growth makes an investment case even more compelling if you are a long-term investor. While 25X earnings is still a hefty price in most cases, strong growth can quickly burn off a premium. Analyst projections for FY20 of $6.20 per share place the stock at just 21.6X next year's earnings. Even if Visa falls a little short of expectations, it would take a complete collapse for the stock not to be worth significantly more in five years than it is now. That is why it is such a silly notion to sell a stock like Visa when minor headwinds emerge.

Even from a cash perspective, Visa's cash flow yield of 3.82% is near the highest it has been since early 2015.

Source: Ycharts

Visa is a truly exceptional company that operates a high margin, low CAPEX, oligopoly. The stock is in a multi-month rut, but not due to its own doing. Long-term investors would be wise to consider the buying window that is currently presented. A quick glimpse at a long-term chart of Visa will illustrate that once Visa resumes its climb higher, it may be a while before it takes another break.

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Author Disclaimer: Wealth Insights is an investor and investment author. His content is not geared to anyone's specific investment goals, time horizons, or risk tolerance. Content is for illustrative purposes only and is not intended to displace advice from a fee-based financial adviser. Accuracy of data is not guaranteed.

Analyst’s 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.