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Quick overview of the company
Visa Inc. (NYSE:V) is a global payment technology company that serves more than 15,000 financial institutions and 100M merchants across more than 200 countries. VisaNet, the largest payment system in the world, is operated by the company. It connects cardholders, merchant acquirers, cardholders, and merchants.To enable electronic payments that are fast, secure, and reliable. The company processed more than USD 13 million in payment transactions during fiscal year 2021.
The company enjoys strong business economics. This is evident by its ROIC and EBIT margins north of 35% & 65%, respectively. Because Visa is a dominant player in a duopoly market, such results are possible. Visa is the most trusted brand in the world. Mastercard (MA), and Visa (MA) are two options for banks that want to issue debit/credit cards. The business model is asset-light, which allows Visa to grow without spending a lot of money (capex to sale ratio of around 3.3%).
Economic moats make a difficult task of competing with
Visa’s network is strong and reliable, and it is used by both merchants and issuing banks. It is difficult to replicate such a network because the more Visa cards are used, the more attractive the payment system becomes for merchants. Additionally, the more Visa cards accepted by merchants, the more convenient the payment system becomes for consumers. Payment processing is highly scalable because the majority of operating expenses are fixed. Visa has a cost advantage because the bigger the business, the lower the transaction cost.
Because they give Visas payment network a winner’s position, it is extremely difficult for these two economic moats to combine (network effect & cost advantage). Competing with Visa means building a new payment network, convincing financial institutions, merchants, and consumers to switch to the new alternative. This seems unlikely considering that a smaller payment network will be more convenient and less expensive.
Recent history has provided us with many examples of unsuccessful competitive initiatives. Apple Pay (AAPL), and Google Pay (GOOGL, GOOGL), have both decided to enter the payment space. However, they prefer to build their mobile payment platform using existing payment network infrastructure. The European Payments Initiative sought to create a European alternative payment network to Visa in order to reduce dependence on it. Mastercard. Two-thirds of the financial institutions involved in the project pulled out, forcing the remaining banks and other banks to abandon the project. It seemed that neither the banks nor the merchants were able to make the necessary investment required for the project. It is not surprising that both merchants and banks do not spend money on existing card networks. Banks collect interchange fees, while merchants have payment convenience and access to a wide base of consumers (even though they may feel that the fees are too high).
Strong growth ahead
Visa’s growth rate over the past decade was very healthy. In fact, revenue grew at a 10% annual rate while EPS (and FCF per share) increased at a 21% annual rate due to margin improvement. The number of shares outstanding dropped by approximately -5% each year. Visa is expected to continue to grow revenue at a low single-digit and high double-digit growth rate in the years ahead.
Visa will also benefit from the secular trend towards electronic payment. This is in addition to the increase in consumer spending, which has averaged slightly more than 4% over two decades. Although electronic payments are highly integrated in the United States, there is still a need for cash accounts. 20/25%The US can still account for a greater share of total payments (in volume) thanks to the development in e-commerce, mobile and other technologies that are more prone towards card payments. The majority of regions in the world are not as well connected. The cash share of all payments in Europe is accounted for by the cash.>70%Cards account for slightly less than 25% of all transactions. Card penetration in less developed countries is even lower than that of developed countries, which opens up many years of growth possibilities. Finally, Visa is developing several initiatives in order to target new markets such as business-to-business, government-to-consumer or person-to-person transactions. The market in which Visa operates is the business-to-consumer one.USD 30 Trillion (Vs. Visas revenue of USD 27B; other opportunities amount to USD 155 Trillion.
What about the inflation environment?
While inflation has not been a major issue for years now, it has started picking up since 2021. Many market participants think that high inflation will continue, and that economic growth may slow or even stop after the war in Ukraine. We believe Visa is able to thrive even in difficult economic periods, especially when inflation is high. However, it is impossible for us to predict the future.
Companies with a high cost base (low margin) and little pricing power are most affected by inflation. This is because inflation has a greater impact on their profitability. Inflation should not be feared by high-margin businesses like Visa. First, Visa is a high-margin company, as evidenced by its 65%+ EBIT margin. This means that less than 35% are at risk from cost inflation. Another reason is that a large percentage of revenue (>70%) automatically and fully considers inflation. Visa charges fees that are based upon a percentage of total consumer expenditure. In other words, inflation has a greater impact on revenue than costs. This is a net benefit.
Visa services are essential services that banks and merchants need. Therefore, in a recession, the demand should not be affected. Visa also benefits from the cash to card transition, which should not be affected by a lower level economic activity. Consumer spending is resilient, as evidenced by the drop of less than 5% in US consumer spending during 2008’s global financial crisis.
Inflation fears could cause valuation multiple compressions. We believe absolute valuations don’t need to be stretched (see next section), which reduces the likelihood of multiple compression. Changes in valuation multiples are not significant over the medium term (except in extreme cases), accounting for 15% of the total shareholder returns on average.
Valuation
Visa trades at 3.8% FCF yield. This seems attractive for quality-business growth earnings and FCF around 20% annually. Its closest peer Mastercard trades at 2.6% FCF yield, which is justified by its higher growth profile. Both traded at an FCF yield of 3.2% on average in the past. The S&P 500 trades at a 4.4% FCF Yield (equivalent of a 15% Visa discount), but it has a lower growth profile and lower profitability.
We believe the stock is still a good value from a valuation multiple perspective. It can provide a double-digit return over coming years and protects against inflation due to its combination of high-margin and inflation-indexed revenue.
Risques
The Federal Reserve will soon be launched FedNowExpected for 2023/2024, a real-time payment system that is more of a new payment network. It could pose a serious threat to existing card networks if it is adopted by all participants. The majority of payment fees are associated with interchange fees that remunerate card networks, not banks. Therefore, we aren’t sure banks will push for this type of service.
New payment methods like BNPL (Buy Now, Pay Later) and same-day ACH (Direct debit transactions), or any other payment solution, could disintermediate the card network. They must be affordable, profitable for banks, and easy for consumers to use in order for them to succeed. It should also be able to offer a solution that Visa cannot duplicate. Visa has been able to turn a potential threat into a business opportunity by being able to effectively deal with BNPL transactions.
Blockchain, cryptocurrencies and any other new technology could eventually allow money transfers without the need to use a payment network. However, existing blockchain technologies cannot handle millions of transactions. Cryptocurrencies should not be considered as a means of exchange (too volatile and lacking trust).