Visa Inc. (NYSE:V) is a global payment technology company that serves more than 15,000 financial institutions across more than 200 countries. The company operates VisaNet, the world‘s largest payment system, which enables fast, secure and reliable electronic payments by connecting cardholders, issuer banks, merchant acquirers and merchants. The platform provides authorization, processing, and settlement services of electronic payments. Visa also offers prepaid, debit and credit cards that are issued by financial institutions. During fiscal year 2021(ending September 2021), Visa processed ~165 billion payment transactions for a total value of almost USD 13 billion.
The following illustration is a good example of how a payment transaction works.
Visa generates revenue on a per transaction basis by collecting processing and assessment fees. The former is fixed (around 2 cents per transaction) and paid when Visa accepts a transaction and sends it across its network. The latter is collected every time that a transaction is made with a Visa branded card and is based on a percentage of the transaction value (around 14 bps). Note that fees will be less important for debit transactions (VS credit) and more important for cross-border transactions (VS domestic). However, merchants pay much more than just a few basis points per transaction in credit card fees (around 2% of total payment) because Visa collects interchange fees on behalf of issuer banks and acquirers also collect acquiring fees.
A competitively advantaged business
Visa, just like Mastercard (MA), benefits from the strength of its network. Indeed, a bank that wants to issue debit/credit cards that are globally recognized and accepted have mainly two options: Visa and Mastercard. Visa partners with more than 15,000 financial institutions globally that have issued more than 3.8B Visa cards that are accepted in more than 100M merchant locations.
The following table highlights the dominant position of Visa that has a network much bigger than Mastercard, the second largest player in the US (UnionPay is larger but focuses only on the Chinese market). Having a dominant position for a payment network is much more important than for most businesses. Indeed, 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 and so on.
In addition, payment processing is a highly scalable business because most operating expenses are fixed. As a result, the larger the business, the lower the cost per transaction, which offers, Visa a cost advantage.
Such barriers to entry are extremely difficult to overcome, as it requires building a new payment network and convincing financial institutions, consumers and merchants to switch to this new alternative, which seems unlikely given the fact that a new smaller payment network will be less convenient and more expensive.
V stock key metrics
Visa enjoys very attractive economics because of the duopoly nature of the industry, attractive growth prospects and the strong barriers to entry. The return on invested capital averaged 35% over the last decade (22% including goodwill but Visa does not aggressively pursue external growth opportunities). Such result is the combination of an asset-light business model and a very high operating margin (>60%).
In addition to be very profitable, Visa was able to significantly grow its business. Revenue, EPS and FCF per share have increased at 10%, 21% and 21% CAGR over the last ten years, respectively. EPS and FCF per share did outgrow revenue growth because of margin improvement and the reduction in the number of shares outstanding (roughly -5% per year). Finally, the management team has been quite conservative by avoiding the use of debt as highlighted by its net debt / EBITDA ratio of -0.1x and its conservative use of debt since its IPO.
What is Visa‘s long-term outlook?
Total consumer spending and the percentage of transactions paid with Visa‘s solutions are the key revenue drivers. Consumer spending has historically been very stable and has grown around 5% per year. While it is difficult to forecast macroeconomic data, we believe that a mid-single growth rate is possible going forward. It is interesting to note that Visa is protected against the inflation because Visa collects a percentage of total consumer spending, which incorporates the impact of inflation.
ncrease in consumer spending only benefits Visa if the transactions are paid with Visa‘s payment solutions, especially cards. As a result, the cash-to-card penetration is also a very important growth driver. While electronic payments are already highly penetrated in the US (cash accounts for 20/25% of all US payments in volume), we believe that it can further increase while compared to Sweden that aims to become a cashless society. In Europe, cash‘s share of all payments account for >70% while cards represent slightly less than a quarter of total transactions. This trend is even more pronounced in less developed countries. Therefore, Visa still has the opportunity to further penetrate the payment market and gain market share over cash and checks.
The growth in mobile and e-commerce will support the cash-to-card penetration, as these transactions are more prone to electronic payments. In addition to bring additional transactions to Visa, it will also boost revenue per transaction because card-not-present transactions earn higher fees (in order to take into account the risk of fraud) and potentially increase the number of cross-border payments.
Finally, Visa wants to target new markets that, if successful, will send Visa in a new dimension. Visa currently operates in B2C, a market estimated to be worth USD 30 trillion by the company. Visa would like to develop solutions for business-to-business transactions (think payment of invoices to suppliers) which is still a slow, manual process. That new market alone is more than four times bigger than the B2C market, which could offer Visa many years of very strong growth.
To sum up, we believe that Visa can sustain a low double-digit revenue growth rate over the coming years.
Existing business threats seem overdone
Investors are worried about a long list of potential threats that could jeopardize the growth trajectory. Nevertheless, the group is still growing nicely which is already a proof that Visa is not facing business disruption yet. Disintermediation, increasing competition and stricter regulations are the main worries.
Digital wallets, BNPL, cryptocurrencies and account-to-account solutions (ACH) are the primary source of concern. Indeed, if successful, these technologies could disrupt Visa and make it obsolete. However, we believe that disrupting payment networks is a daunting task at best.
Let’s start with digital wallets! A few years ago, technology companies such as Apple (Apple Pay) and Google (Google Pay) entered into the payment space. Fears were related about those companies creating their own payment network. However, as previously explained, creating a payment network is difficult because it requires negotiating with hundreds of issuing banks and convince millions of merchants to affiliate to the network. Both players finally decided to build their mobile payment platform on top of the existing payment network infrastructure.
The European Payments Initiative is just another example of a threat that fails to compete with card networks. This initiative aimed to create a European alternative to Visa and Mastercard. However, twenty banks, of a total of thirty-three, decided to withdraw from the project, forcing the remaining banks to abandon the project.
Same-day ACH (Direct debit transactions) allows both debit and credit transactions to be processed several times on a daily basis. Merchants could be interested in such solutions as it is far less costly than using cards. However, we do not think that customers will accept to share their bank account information with merchants, and using a card is more convenient and secure for consumers. Besides, it would also be less lucrative for issuing banks.
The Federal Reserve will soon launch FedNow (expected for 2023/2024), a real-time payment service. From our understanding, this service is more or less a new payment network. We believe that adoption will depend on banks’ willingness to push for that service, which is something difficult to expect. Indeed, the network is expected to be more affordable for merchants but the bulk of payment fees are related to interchange fees that remunerate issuing banks (not card networks). Without further information, we prefer to wait to see what is going to happen once the service is available.
Blockchain and cryptocurrencies could eventually enable money transfers without the need of using payment network. However, we believe that existing technologies are not able to handle the processing of millions of transactions and cryptocurrencies are not yet considered as a medium of exchange (too volatile, lack of trust…).
Finally, BNPL (Buy Now Pay Later) was initially considered as a threat because this solution could route payments outside the card network by using ACH. However, Visa has been reactive to offer similar solutions and had partnered with BNPL fintechs such as Afterpay, thus card networks are not disrupted by this new product. In fact, card networks benefit from BNPL as they generate more processing fees. Visa collects a processing fee (fixed fee) for every monthly payment instead of only one for a non-BNPL transaction.
Did Visa beat earnings?
Visa‘s second quarter results delivered strong quarterly numbers, which were above consensus estimates. In short, revenue grew 25% year on year to reach USD 7.19B (consensus at USD 6.84B), supported by a strong recovery in cross-border transactions and payment volume. Adjusted EPS came out at USD 1.79 (USD 1.70 under GAAP), a 23% YoY increase and above the USD 1.65 consensus estimate. EBIT margin reached 66.8%, a net improvement compared to 62.5% a year ago.
The recovery in cross-border transactions and the solid financial guidance are the main takeaways. The lockdowns across the world resulting from the pandemic have weighed negatively on Visa‘s growth prospects and profitability as cross-border transactions generate much higher fees than domestic transactions. Cross-border volume excluding intra-Europe transactions (which are priced similarly to domestic transactions) grew 47% YoY. The level of cross-border transactions (excluding intra-Europe) was a positive surprise because the management team expected that business to be around 90% of 2019 level by fiscal year-end whereas it is now expected to reach 2019 level.
Going forward, Visa believes that full year revenue can grow high teens to 20% YoY despite a 4% headwind from Russia and 2% from FX, which clearly show the strength of the underlying business as it can offset an unexpected headwind of 6%.
Mastercard has published very strong results that confirm the recovery in cross-border transactions. According to its CEO, cross-border travel is above 2019 levels for the first time since the pandemic began and ahead of Mastercard‘s expectations.
Is Visa stock at fair valuation?
Visa is currently trading at a 3.7% FCF yield, which seems attractive for a quality-business growing earnings and FCF around 20% per year. It closest peer, Mastercard, is trading at a 2.5% FCF yield even though we have to admit that it also has a better growth profile. Historically, both have traded at an average FCF yield of 3.2%. While not very cheap from a valuation multiple perspective, we believe the stock is still attractive as it can offer a double-digit return over the coming years and provides an excellent protection against inflation thanks to the combination of high-margins and inflation-adjusted fees (percentage of total spending).