Visa: Buying Opportunity Of The Decade
- Visa has seen its shares decline rapidly in recent weeks, on the back of new COVID fears and weak sector performance.
- Visa will do well in the long run, however, as there are multiple growth drivers that will propel Visa's earnings per share upwards.
- Visa trades at a clear discount compared to the historic norm, and the valuation decline it has experienced in recent weeks is massive, providing a great buying opportunity.
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Payment stocks are out of favor right now, and that, combined with worries about the new COVID variant, has sent shares of Visa (NYSE:V) down by well above 20% over the last couple of months. This has made Visa comparatively cheap, and since the company remains a quality giant with a compelling growth outlook over the coming years, investors may want to use this steep selloff to enter a position in this cash flow king at an attractive valuation.
An Out-Of-Favor Industry Gets Hit By New COVID Fears
Payment stocks have already underperformed prior to the emergence of the new COVID variant Omicron that was first found in South Africa, as Visa, Mastercard (MA), PayPal (PYPL), Global Payments (GPN), and many more payment stocks have underperformed the market in recent months. In some cases, this can be explained by stretched valuations, but that was not the case with all of these companies. Other factors that could explain the weak performance of these stocks include worries about decentralized finance technologies such as cryptocurrencies, although I believe that these fears are way overblown. Bitcoin, for example, is primarily seen as a store of value or appreciating asset, whereas the actual amount of money that is transferred on the network for payment purposes is negligible -- not too surprising, considering the fact that payments via Bitcoin are slow and expensive, as reported here by the Financial Times. Since payments via credit cards are way faster, come at no cost for the consumer, and since credit cards offer other advantages on top of that, such as fraud protection, points rewards, etc. I do not believe that cryptocurrencies and related technologies will be a huge threat to credit card companies.
Payment companies also got hit by news about the new COVID variant. Some countries have put travel restrictions in place, which will presumably be a headwind for companies such as Visa, as less international travel leads to lower cross-border fees. It seems to me, however, that this will be a short-term issue only. Travel restrictions will not be in place forever, and in case they remain in place through the winter months (which is not guaranteed, as there are also reports that the new variant only results in mild symptoms), then Visa and its peers will not face a long-lasting headwind. It seems pretty clear that Visa's business will be back to "normal" a couple of years down the road, and potentially in 2022 already, thus the recent sell-off seems like an overreaction to a short-term issue -- giving investors an opportunity to buy at a discount.
Visa: The Opportunity Of The Decade?
Visa is a quality company: It has excellent fundamentals, such as a free cash flow margin of more than 50%:
For every dollar in revenue that Visa generates, more than 50c have ended up as free cash on Visa's balance sheet, allowing the company to finance attractive shareholder return payments via dividends and buybacks. Since Visa's technology is already in place and since the company should benefit from fixed cost digression and operating leverage, it has to be expected that the FCF margin on each additional dollar in revenue is even higher than the already very high "average" FCF margin the company reports. Likewise, Visa also sports excellent returns on capital, with a return on capital employed of 25% and a return on equity of 36% (per YCharts), making this a strong compounded over the years. Visa's balance sheet is very clean as well, which is rewarded by a strong AA- credit rating.
Strong companies such as Visa, especially if they also have a great track record and compelling growth potential, usually trade at high valuations. This also holds true for Visa, which used to trade at well-above-average valuations:
Visa's 3-year, 5-year, and 10-year median earnings multiples stand at 33-36, which represents a clear premium compared to how the market used to trade in the same time frame. Visa's valuation premium has, however, declined massively in recent weeks. Based on current forecasts for this year's expected earnings per share, Visa is trading for less than 28x current net profits today. This represents a discount of ~20% compared to how the company was valued in the past. When we account for the fact that the broad market got more expensive over the last couple of years, Visa's discount compared to its historic valuation becomes even more remarkable -- the stock has become a lot cheaper in a time frame during which many other equities became more expensive. This does, I believe, represent a pretty clear investment opportunity.
My belief that Visa is offered at an attractive price today is also underlined by the following chart:
Visa's EV to EBITDA multiple, which accounts for debt usage and cash held on the balance sheet, has dropped by more than 30% from recent highs. The only other time when we have seen a drop of more than 30% was during the peak of the COVID panic in early 2020. This drop did not last long at all, and was, in retrospect, a great time to buy. A similarly large drop in Visa's valuation, such as the one we are experiencing right now, has, outside of the COVID panic, never occurred over the last decade, and does, I believe, represent an attractive buying opportunity.
Growth Drivers Remain In Place
Visa will, I believe, be able to grow its profits at an attractive pace in the coming years. This will be possible through several contributing factors. First, consumers in many countries are in a strong position right now -- stimulus payments, fewer opportunities to spend money outside of one's home in 2020, and a rebounding economy have resulted in ample cash available for spending for consumers. We see this, for example, in consumer spending growth that is forecasted at more than 8% for the current year. More consumer spending means that, all else equal, Visa and other credit card players will take in larger revenues. There is another factor at play that will allow Visa to grow its revenue faster than the overall consumer spending growth rate, however. Non-cash payments, as a percentage of overall payments being made around the globe, are growing:
This trend has been in place for many years, and forecasts see it remain in place in the coming years. As users use less cash and swipe their cards more often, or use technologies such as Apple Pay (AAPL), credit card players such as Visa will be taking their share from a growing pool of payments being made around the world. Especially in international markets, such as the vast Asia-Pacific region, there is a lot of growth potential. In the above chart, we see that Asia-Pacific non-cash payments totaled 280 million in 2020, about 1.5x as much as the 185 million in North America -- there are way more than 1.5x as many consumers in the Asia-Pacific region, compared to North America, however. Over the years, more and more of those consumers will start to use non-cash payment options, which will allow for compelling market opportunities for Visa and its peers. As a global player with established business relations in many countries around the world, Visa is a prime candidate for capturing a large portion of this market potential.
Visa's net profits should also see tailwinds from expanding margins in the coming years. Visa's margins are already very high, but since proportional costs for each added customer, or each additional transaction, are very slim, operating leverage and fixed cost digression should result in additional margin expansion in the coming years. Per YCharts, Visa's gross margin is around 80%, so one can expect that around 80c will flow through to the (pre-tax) bottom line for each incremental dollar in revenue.
Last but not least, Visa's earnings per share growth will benefit from the company's rapid buybacks:
Over the last decade, Visa has bought back more than 20% of its shares on a net basis (buybacks were even higher on a gross basis, but the company does issue shares to employees and management as part of their compensation). This means that each individual share's portion of the overall company has grown by 27% over the last decade, providing a pretty sizable boost to the value per share and to the company's earnings per share growth.
It can be expected that Visa will continue to buy back shares at a meaningful pace. Thanks to the company's strong cash flows and the aforementioned below-average valuation, it would make sense for Visa to ramp up its buyback pace as long as shares remain this cheap and trade at a clear discount compared to how they were valued in the past.
Visa is forecasted to earn $11.50 per share in 2025, although it seems likely that actual results will be better -- the company has beaten EPS estimates in an incredible 19 out of the last 20 quarters:
Source: Seeking Alpha
When we assume that Visa will continue to perform better than expected, actual earnings per share in 2025 could total around $12, as Visa has oftentimes beaten EPS estimates by 5%-10% in the past. If Visa were to trade at 23x net profits in 2025, this would equate to a share price of $276 four years from now, which would allow for total returns of ~10% a year from the current level, including the dividend yield of 0.8%.
If Visa were to trade at 25x net profits in 2025, which would still represent a clear discount compared to how shares were valued in the past, and compared to how they are valued today, then Visa's share price could climb to $300 over the next four years, which would result in annual returns of 12%. If Visa would trade at 30x net profits in 2025, which would be more expensive than shares are valued today, but which would still be inexpensive relative to valuation multiples in the past, then a share price of $360 would translate into total returns of 17% a year.
Even the most conservative of these scenarios, where Visa returns around 10% a year while experiencing considerable multiple compression, is still a pretty good one overall. I thus believe that Visa is an attractive investment at current prices -- especially when we consider the aforementioned discount to the historic valuation range and the steep valuation decline Visa has experienced in the very recent past.
Visa is a great company, but great companies oftentimes are pricey. That also used to be the case here, but in recent months, Visa has become a lot cheaper. Right now, investors can buy shares at a clear discount to the normal valuation range, and the valuation decline Visa has experienced during this sell-off is an absolute outlier -- on par with what happened during the initial COVID panic. I believe that Visa is an attractive investment right here and that investors can reasonably expect total returns of at least 10% a year over the coming years -- depending on the valuation a couple of years down the road, returns could also be way higher.
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Analyst’s Disclosure: I/we have a beneficial long position in the shares of V, MA, GPN either through stock ownership, options, or other derivatives. 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.
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