Visa Inc. (NYSE:V) has been around since 1958, but just since 2007 as a standalone publicly-traded company. It's one of the world leaders in digital payments, and processed 164.7 billion transactions in 2021 alone. Looking back to the year preceding the company's IPO, there were 1.25 billion Visa cards in circulation. In the calendar year 2020, 3.59 billion cards were in use globally, according to The Nilson Report Issue 1199 (June 2021). This translates to the worldwide cards' penetration having tripled in the last 13 years.
Visa has profited from the long-lasting trend of cash displacement that continues around the world, especially after the pandemic which redefined the way people pay. It has translated into constant, relatively undisrupted earnings growth, and the stock price has followed.
Visa operates in a duopoly where its main competitor is Mastercard (MA). For years, these were the two players in the payment processing space with an incredible moat that seemed never to be disrupted. Some say that you can't lose by investing in a business that functions in a duopoly. This might have been true, but the Boeing (BA) case can be used to counter this statement.
Anyway, Visa does operate in a duopoly to a large extent. However, competition in the payment processing space has arisen and seems to chip away at the most significant player's position in the global market. Yet, this doesn't necessarily mean that Visa's growth is at risk.
A part of the due diligence when analyzing businesses is to make reasonable assumptions on the future total addressable market (TAM) in which the company operates, as well as the corresponding outlook for the company itself. This determines the multiples that will be applied in the valuation models. Since Visa is already a large company, one can expect revenues to grow at a slower rate. However, if the company can sustain moderate growth by tapping into new spaces and expanding its current revenue streams, sales numbers can still have a long way to run and investors may be rewarded accordingly. An example of a company that keeps finding new ways to grow its revenues despite its size is Apple (AAPL).
The core of the Visa business is Data Processing and Service, which account for 74.8% of gross revenues in FY 2021. The essential products associated with this part of the business are credit, debit, and prepaid. Despite the fact, that Visa has offered its cards since 1958, the company sees an enormous $18 trillion opportunity in this space. The targeted audience is the group of consumers who still make payments in cash or with the use of checks. Visa's new capabilities that can accelerate the acquisition of new clients are:
The company's strong position in the market and the benefit of one the most recognizable and trusted brands in the world (ranked 9 according to morningconsult.com) give Visa an advantage over the competition in this race. Besides that, the company expands to new areas where new opportunities emerge. The picture below gives a good overview of what Visa is after.
While the estimated untapped TAM in consumer payments accounts for $18 trillion, an opportunity in New Flows is more than tenfold! It's worth noting that the components of this segment are already in use in the payment processing industry. In some cases, they are very well established - like P2P. Some can say that this space is already crowded and dominated by PayPal (PYPL) and Block (SQ) with their popular products which are PayPal wallet, Venmo, and Cash App. When it comes to Venmo, it has indeed been gaining market share by reaching over 70 billion users but only in the USA, while it's not accepted anywhere else in the world. Cashapp has also seen success in recent years, but again it operates in only one country except for the USA which is Great Britain. And PayPal, although widely popular internationally still loses oftentimes to regular bank transfers even in the most developed countries in Western Europe, such as France or Germany. This shows that the potential even for the popular segment such as P2P is still there. Visa has everything to become a significant player in this game.
Those who follow Warren Buffett and his moves in the market most probably noticed that he divested from Visa recently. While buying a stake in a business means that an investor strongly believes in the company and that the investment will deliver superior returns, selling can mean many things that often have nothing to do with the divested equity but rather with the whole portfolio. Nevertheless, Berkshire Hathaway (BRK.A, BRK.B) sold a significant portion of its Visa stake between Q2 2020 and Q4 2021, which amounted to 575,425, and 1,265 thousand shares, respectively. These moves corresponded with the reduction of 5.44%, 4.26%, and 13.23% of the position in Visa.
As mentioned, selling a stake in the business doesn't necessarily have anything to do with a loss of conviction by a seller. However, looking at the moves made by value investors, whose activity is rather low and whose buys as well as the sells happen less frequently, can deliver some insights. It can be specifically valuable when supported by comments from the conference calls. Warren Buffet mentioned his position in Visa during the shareholder meeting in 2018 after being asked why Berkshire Hathaway hadn't increased its stake in Visa and Mastercard, even though their performance was significantly better than American Express's of which Buffet owned 17% at that time. While elaborating on the subject, he and the vice president Charlie Munger both agreed that:
Payments are a huge deal worldwide and you have all kinds of smart people working on various ways to change the payment arrangements.
It was followed by Munger's remark:
and destroy what we have now.
He also added that there is a "tiny cloud" on the horizon of the payments processors which is WeChat owned by Tencent (OTCPK:TCEHY) which according to both gentlemen can disrupt the business in which Visa, Mastercard, and American Express (AXP) operate. They also expressed strong convictions about American Express and the solid numbers it continued to deliver. Besides that, Berkshire's managers were responsible for the purchase of Visa, not Warren Buffett or Charlie Munger. Most probably they also stay behind the scenes with the recent selling. Nonetheless, these cool-headed remarks made by Buffett and his business partner give an interesting perspective of what the greatest investors of all times think of the industry, disruption, and individual businesses in the space.
Another value investor who is called a "British Warren Buffet" - Terry Smith, the owner of the Fundsmith Equity Fund - is also worth mentioning here. His investment strategy relies on three fundamental principles which are:
1. Buy good companies; 2. Don't overpay; 3. Do nothing.
These are very similar to what Warren Buffett and Charlie Munger preach. He is a proponent of having a high-quality, concentrated portfolio consisting of 20-30 fundamentally strong global growth companies which are held for the long term. Taking into account his investment philosophy, there is no surprise that the leaders in the payments processing industry which are Visa and PayPal have a place in his holdings. What may be surprising is that he sold 18.6% of his position in Visa in Q1 of 2022, which now accounts for 4.29% of his entire portfolio. In the same period, he also reduced his PayPal stake by 19.53%, being 4.16% of his investments after the recent sale. Based on Terry Smith's activity in relation to these two names, it seems he realized gains and moved into cash.
While getting rid of PayPal prevented the fund from being down more than 50% on the position, Visa has held very well in the last six months. It has performed significantly better than S&P 500 and it beat the names mentioned in the article such as PayPal and Tencent. One more company included in the comparison is Affirm Holdings (AFRM), which was one of the "hot stocks" not long ago. The performance of these names shows also that in times of uncertainty and fear in the market, the money flows to the businesses with strong fundamentals, great balance sheets, and devoted management which delivers solid numbers over a long period of time. And Visa belongs to this group undoubtedly.
Visa is one of these companies, that it's difficult to value. Over the last ten years, Visa's P/E Ratio stayed between 30 and 40 with relatively short periods of time when it was outside of the range. Over these ten years, the company's earnings per share (EPS) grew from $0.79 in 2012 to $5.63 in 2021 which corresponds to an astonishing 24.4% compound annual growth rate (CAGR). What it tells an investor, is that the market applies a P/E between 30 and 40 with an expectation of earnings growth in the mid-twenties. As long as Visa keeps showing such growth, its P/E should stay in the aforementioned range and the stock price will follow.
However, according to the predictions on Seeking Alpha, the EPS CAGR in the next 3-5 years is projected to be 18.0%, which is substantially lower than the previous 24.4%. Yet Visa is still trading at a P/E of 31.0. The main question is if Visa will find ways to beat analysts' estimates by delivering stronger than expected numbers.
Another way to look at the valuation of Visa is to plot a chart of the stock price and the company's earnings by multiplying $1 of earnings by 15. The new "earnings line" equals the stock prices at a P/E=15. This can be used as a fast assessment of the stock valuation and it was introduced by a legendary investor - Peter Lynch in his book "One up on Wall Street," who explains:
A quick way to tell if a stock is overpriced is to compare the price line to the earnings line. If you bought familiar growth companies - such as Shoney's, The Limited, or Marriott - when the stock price fell well below the earnings line, and sold them when the stock price rose dramatically above it, the chances are you'd do pretty well.
Yet, based on the chart it looks like Visa has been overpriced since it went public. To make things even more difficult, investing in the company at any time since 2008 would have brought staggering returns. What does it mean for investors?
It's an excellent example of the complex nature of valuation. Peter Lynch's chart might not apply to a relatively low volatile stock with a high growth over a long period of time, unbeaten moat, and lack of events that send the stock price sharply lower. In this particular case, the market seems to have been right, by applying high multiples to a high-growth company with a strong moat. And indeed these are the most important aspects that affect the P/E ratio. In the case of Visa, they have seemed to be fully justified.
In the article released by pwc, "Charting a course amid evolution and revolution," an insightful diagram was presented which shows the projected development of the transactions worldwide.
As one can notice, the next five years will represent a massive opportunity for payment processors. With a projected 82% cumulated growth globally, Visa is well-positioned to expand and thrive. This period is to be followed by five more years of increase of 61% in the number of cashless transactions. This shift surely encourages competitors to participate in the payment transformation. Nonetheless, Visa's position in the market and the company's performance provide investors with strong arguments for the business that has done so well regardless of the macroeconomics and market downturns.
Projected numbers of the transaction volume can be used as a base for a valuation model of the business.
After applying the estimates and assuming a very conservative P/E Ratio compared with historical values, the fair value of Visa is around $180.47 and will raise to $218.78 by the end of FY 2023. However, if one believes these estimates and the projection of the fair value of $662,81 in 2030, let's look at how the investment in Visa would pay off if the shares were acquired today for the price of $211.33. Having used the current price, the compound annual growth rate would be 15.36%. This would be a terrific return that would have beaten the market over any 5, 10, or 20-year period. For anybody who agrees with the estimates and is satisfied with the returns, Visa might be the right investment.
It's all about the estimates. This is what makes investing tricky. An investor has to get acquainted with the business and its past performance and project the numbers into the future based on his knowledge and unbiased assumptions. Unfortunately, nobody knows what will happen in the future. Even conservative estimates can turn out to be far from reality whenever an unexpected, impactful event happens.
Analysts talk about the competition in the payment space which can pose a threat to the companies such as Visa. A counterweight to this argument would be - trust. Consumer trust is a huge factor especially when it comes to payments. Competition shouldn't be neglected but it shouldn't be magnified. Besides competitors, there are regulations or anti-competitive rules. All these risks are so unpredictable that it's very difficult to assess them and apply them to valuation models. One of the methods might be to set even more conservative multiples which would reflect rare, unexpected events.
Visa is currently the third to last Dow Jones component when it comes to the 1-year performance with a 9.8% decline. Considering the company's expanding services, the development of the payments volume worldwide, Visa's valuation, and possible returns, it emerges as a compelling investment. Its stability and the quarterly dividend may add to the list of pros for a potential investor. The company's valuation has always been a tough nut to crack and it has confused investors for many years. Waiting for a drop in price was not the best strategy.
An investor needs to consider the advantages and disadvantages of the entry at this price and compare it to other options the market offers. By applying Terry Smith's philosophy backed up with the valuation model presented in the article, Visa looks tempting. Nevertheless, thorough due diligence needs to be done before putting any amount of money to work.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of V 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.