Quick overview of the company
Visa Inc. (NYSE:V) is a global payments technology company serving more than 15,000 financial institutions and 100 million merchants in more than 200 countries. The company operates VisaNet, the world’s largest payment system, connecting cardholders, issuing banks, merchant acquirers and merchants. to enable fast, secure and reliable electronic payments. In fiscal 2021, the company processed 165 billion payment transactions totaling more than $13 billion.
The company enjoys a very strong trading economy, as highlighted by an ROIC and EBIT margin north of 35% and 65%, respectively. Such results are possible because Visa enjoys a dominant position in an industry duopoly. Indeed, Visa and Mastercard (MA) are the two real options when a bank wants to issue a debit/credit card. Furthermore, the business model is asset-light, which allows Visa to grow without having to spend a lot of money on its business (capex/sales ratio of around 3%).
Economic moats make it difficult to compete
Visa benefits from the strength of its network, which is reliable and extensive with issuing banks and merchants. Such a network is difficult to replicate because the more consumers use Visa cards, the more attractive the payment network becomes for merchants and the more merchants accept Visa cards, the more convenient the payment network becomes for consumers, etc. Additionally, payment processing is a highly scalable business because most operating expenses are fixed. Therefore, the larger the company, the lower the cost per transaction, giving Visa a cost advantage.
The combination of these two economic moats (network effect and cost advantage) are extremely difficult to overcome as they place Visa’s payment network in a win-win position. Indeed, competing with Visa requires building a new payment network and convincing financial institutions, consumers and merchants to switch to this new alternative, which seems unlikely given that a new, smaller payment network will be less convenient and more expensive.
Recent history has given us several examples of failing competitive initiatives. Apple Pay (AAPL) and Google Pay (GOOG, GOOGL) decided to enter the payment space but preferred to build their mobile payment platform on top of existing payment network infrastructure. The European Payments Initiative aimed to create an alternative to the European payment network to reduce reliance on Visa and MasterCard. However, two-thirds of the financial institutions working on this project decided to withdraw from the project, forcing the remaining banks to abandon the project. It seems that neither the banks nor the merchants were ready to make the necessary investments for the project. Such an end is not surprising given that banks and merchants are not spending money to use existing card networks, and these existing solutions are benefiting. Indeed, banks collect interchange fees and merchants benefit from ease of payment and access to a large consumer base (even if they may consider the fees associated with these services to be too high).
Strong future growth
Visa has been able to grow at a very healthy pace over the past decade. Indeed, revenue increased at a CAGR of 10% while EPS and FCF per share increased at a CAGR of 21% due to improved margins and share buybacks (the number of shares in circulation has decreased by around -5% per year). Going forward, we believe that Visa will continue to grow its revenues at a high single-digit/low double-digit growth rate over the next few years.
In addition to benefiting from the growth in consumer spending (averaging just over 4% over the past two decades), Visa will benefit from the secular trend towards electronic payments. Even though electronic payments are already heavily penetrated in the United States (cash accounts for 20/25% of all US payments by volume), they can still represent a larger share of total payments thanks to the development of electronic commerce and mobile who are more inclined to card payments. In addition, most parts of the world are significantly less penetrated. In Europe, the share of cash in all payments is >70%, while cards account for just under a quarter of total transactions. Less developed countries lag further behind in terms of card penetration, offering many years of growth opportunities. Finally, Visa is developing several initiatives to target new markets such as business-to-business, government-to-consumer or person-to-person transactions. The business-to-consumer market, the market in which Visa operates, is worth $30 trillion (compared to Visa’s revenue of ≈ $27 billion), while other opportunities are worth $155 trillion .
What about the inflationary environment?
Although inflation has not been a problem for years, it has started to accelerate since 2021. Since the war in Ukraine, many market participants believe that high inflation will persist and economic growth will slow (and could even become negative). While it’s impossible to predict the economy with any high degree of accuracy, we believe Visa is well positioned to thrive even during tough economic times, especially times of inflation.
Inflation mainly weighs on companies with a high cost base (low margin) and no pricing power, as inflation has a much greater impact on their profitability. High-margin companies like Visa shouldn’t fear inflation. First, Visa is a very high-margin business, as highlighted by its EBIT margin of over 65%, which means that less than 35% of revenue is likely to suffer from cost inflation. Secondly, a large part of the turnover (>70% of the total turnover) takes inflation fully and automatically into account. This is because Visa collects fees based on a percentage of consumers’ total spend. In short, inflation affects more revenue than cost, which is a net positive.
In a recessionary scenario, the demand for Visa services should remain relatively stable as Visa offers essential services for merchants and banks. In addition, Visa benefits from the transition from cash to card, which should not suffer from less economic activity. Finally, consumer spending is relatively resilient, as evidenced by the less than 5% drop in US consumer spending during the 2008 global financial crisis.
From a valuation perspective, inflation fears could still lead to multiple valuation squeezes in the near term. However, we believe that absolute valuations are not stretched (see next section), reducing the risk of further multiple compression. In the medium term, variations in valuation multiples are almost insignificant (except in extreme cases), representing on average only 15% of total shareholder return.
Visa is currently trading at a yield of 3.8% FCF, which looks attractive for a quality company whose earnings and FCF are growing at around 20% annually. Its closest counterpart Mastercard is trading at a yield of 2.6% FCF, which is somehow justified by a better growth profile. Historically, the two have traded at an average FCF yield of 3.2%. The S&P 500 is trading at a yield of 4.4% FCF (equivalent to a 15% discount for Visa) despite having a much weaker growth profile and weaker profitability.
Although not terribly cheap from a valuation multiple perspective, we believe the stock remains attractive as it can deliver double-digit returns over the next few years and offers excellent inflation protection. thanks to the combination of high margins and inflation-indexed revenues. .
The Federal Reserve will soon launch FedNow (planned for 2023/2024), a real-time payment service that is more or less a new payment network. If adopted by the various participants, it could become a serious competitive threat to existing card networks. However, the bulk of payment fees are related to interchange fees that remunerate issuing banks (not card networks), so we’re not sure banks will push to offer these services.
New payment methods such as BNPL (Buy Now Pay Later) or same day ACH (direct debit transactions) or any new payment solutions could disintermediate the card network. To be successful, these methods must be affordable for merchants, lucrative for banks, and convenient for consumers. Additionally, it should provide a solution that Visa is unable to replicate. For example, Visa has been quite good at processing BNPL transactions, turning a potential threat into an opportunity.
New technologies such as Blockchain and cryptocurrencies or any new innovative technology could eventually make it possible to transfer money without the need to use a payment network. However, we believe that existing blockchain technologies are not capable of handling the processing of millions of transactions and that cryptocurrencies are not yet considered as a medium of exchange (too volatile, lack of trust…).