Visa: a price worth paying

A defendable market position, sky-high margins, excellent cash conversion, "network effects", huge room for growth: global payments giant Visa (US:V) possesses each of these qualities and more. Despite big dents to consumer confidence and spending over the last year, the group’s position at the centre of commerce looks unassailable and should even accelerate as we emerge from the pandemic. Long before Covid-19 struck, these strengths were reflected in a deservedly rich rating, and the stock has a worthy place among our World’s Best Shares.

The easiest way to understand Visa is through its four revenue sources, the largest two being: service fees paid by credit and debit card issuers as well as merchants' banks for access to Visa’s network and payment services (34 per cent of the total); and data processing charges for settling transactions (39 per cent). The rest of the group’s top line comes from transactional fees for cross-border and cross-currency payments (22 per cent), and other fees from licensing, consultancy and other data sales (5 per cent).

Stopped at the border

From these gross revenues investors need to strip out client incentive payments – such as discounts, cash payments, rebates and credit – which represent the cost of maintaining relationships and business. These came to $1.7bn (£1.4bn) in the September-end quarter, which also saw net sales of $5.1bn and pre-tax profits of $3.05bn. Although 25 per cent down year on year, the latter figure is still back to roughly what Visa was earning at the end of 2017, highlighting the resilience and growth of a business that still had to navigate lockdowns and the loss of trade from international travel across its core markets in 2020.

Indeed, recent data reveals the impact cancelled holidays and business travel continue to have on cross-border volumes (see chart). For the most recent financial year, gross revenues from this segment fell 19 per cent to $6.3bn – the only division to see a decline in the period, and which in turn accounted for most of the fall in group profits.

With a long and uncertain vaccination roll-out ahead, compounded by the economic scars of 2020, investors should assume that a recovery in international travel will be protracted at best. Until greater clarity emerges on earnings visibility, management is likely to keep forward guidance suspended, too.

However, it is notable that in the Americas region – which accounts for just over half of all revenues (see geography chart) – payments volumes climbed in October and November, even as Covid-19 raged. Then again, this growth has gone hand-in-glove with the accelerated flight to e-commerce, and what RBC analysts call “non-traditional” card purchase categories such as food and drugs. Whether online or in-person, economies’ steady shift to cashless transactions – from the Netherlands to China, and coffee shops to transport systems – has received an enormous, most likely irreversible, boost. This all benefits Visa.

Cashless and cardless

On top of this, Visa continues to sign business-to-business tie-ups, as companies reduce their working capital risks by replacing cumbersome paper-trails with digitised processes. In recent years, a partnership with PayPal, canny deals to provide credit card technology to cryptocurrency firms, and a dominant position in mobile payments – a $2.1 trillion market poised to grow to $3.1 trillion by 2025 – also point to a flexibility to anticipate competition and adapt with the payments sector, rather than seek to dig into an entrenched, highly-profitable position.

It is this position that some view as potentially monopolistic, given Visa’s ability to set so-called inter-charge fees paid by merchants to the card issuers on whose business Visa depends. In the coming years, Visa and its chief rival Mastercard (US:MA) could face growing regulatory pressure on these fees, as well as from smaller fintechs hoping to cut them out entirely.

But these pressures can be faced from a position of strength. Although returns on equity and after-tax profit margins dipped in the 12 months to September, both were above the five-year average at 29.6 per cent and 47.9 per cent, respectively. Cash generation is also superb. Until FY2020, free cash flow was growing at a faster rate than sales and operating profit, and the free cash flow margin – the proportion of net sales converted into cash – has routinely exceeded 50 per cent. Growth has been well managed amid a period of profound change in the industry, which should give investors plenty of encouragement about the future.

Another source of confidence is the group's track record of beating Wall Street forecasts. This should help to temper warranted concern at the shares’ forward earnings multiple of 37, well above the five-year average multiple of 27. The current rating also relects the temporary earnings hit from Covid restrictions. Indeed, Visa trumped already very-bullish quarterly consensus earnings estimates on all but one occasion over that period (see earnings chart), during which time the price of balking at a rich valuation has been to miss a five-bagger stock. If investors can look beyond the near-term macroeconomic pain, analysts think earnings can double to $10.11 per share within four years.

With the infrastructure ownership of a utility, the asset-light balance sheet of a technology giant, brand power that exceeds even the most trusted bank and the growth-chasing outlook of a fintech, Visa is a quality name well suited to whatever emerges from 2021. Buy.