BMO Capital Markets marked Visa (V, Financial) as its top pick in the fintech sector last Thursday. According to Benzinga, BMO Capital sees Visa as a key beneficiary of the global secular shift from cash and checks to electronic payments and set a $99 price target for the credit services company.
Earnings performance
Visa delivered its full-year fiscal 2016 results last October. The $159 billion fintech giant grew its sales by 8.7% to $15.08 billion and a negative 5.3% change in profits to $6 billion. Visa recorded $1.9 billion in expenses in relation to its Visa Europe framework agreement (1). Meanwhile, Visa is expected to deliver its first-quarter fiscal 2017 results on Feb. 2.
“We continue to deliver healthy earnings growth in the face of continued but abating headwinds. We have begun to see the benefits from our acquisition of Visa Europe and strong cost discipline helped our results. At the same time, we are unwavering in our commitment to invest in client partnership opportunities and the further build out of our digital payments capabilities.
“As we enter fiscal 2017, we are positioned well as revenue headwinds will continue to ease, we will continue to see the benefits from Visa Europe in our results, and our strong client franchise continues to grow.” – Charles Scharf, former CEO of Visa
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Outlook
(Financial Results)
For fiscal 2017, Visa expects a midpoint of 17% sales growth and low 30% growth in its diluted earnings per share. On a five-year average, Visa had sales, EPS growth and operating margin averages of 10.4%, 13.97% and 52%.
Acquisition of Visa Europe
In review, Visa acquired Visa Europe for total value of up to 21.2 billion euros ($22.52 billion) in 2015. Visa stated that the Visa Europe counterpart would then have greater access to Visa’s scale, resources and global clients as a result of the integration. Visa was expected to have provided 11.5 billion euros upfront cash and 5 billion euros in preferred stock convertible into Visa Class A common stock.
“We are very excited about unifying Visa into a single global company with unmatched scale, technology and services.
“This transaction is beneficial for financial institutions, acquirers, merchants, cardholders, and other partners, as well as for our employees and shareholders. The Visa Europe team has done a tremendous job building a leading payments system that is trusted and respected across Europe, and together we will bring the power of electronic payments to more people in more places than ever before.” –Â Charles W. Scharf, former CEO, Visa
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Visa, as a result, was to issue $15 billion to $16 billion in senior unsecured debt to fund the acquisition and share repurchases of Class A Visa shares in 2016 and 2017. The share repurchase, in particular, was to offset the effect of the issuance of preferred stock.
According to Visa’s recent annual filing, these preferred shares that were issued to financial institutions are convertible into approximately 79 million shares of class A common stock. This would be equivalent to about $6.49 billion as of last Friday’s closing.
(Annual Report)
Market performance
Past five- and one-year total returns were 27.3% and 14.7% compared to the Standard & Poor's 500 index’s 10% and 16.9% (2).
Valuations
According to GuruFocus data, Visa had a trailing 12-month price-earnings (P/E) ratio of 33 times (industry median 15), price-book (P/B) ratio of 6.2 times (industry median 1.2) and price-sales (P/S) ratio of 13 times (industry median 3.6). Visa also had a trailing dividend yield of 0.71% with a 23% payout ratio and 3.1% share buyback ratio.
(10-K)
Visa
Visa is a global payments technology company that connects various entities including consumers, merchants and financial institutions in more than 200 countries and territories (4). Visa operates its business by fast, secure and reliable electronic payments among its consumers.
Business revenues from the U.S. were approximately 52%, or $7.84 billion, of Visa’s total revenue figures for fiscal 2016. Visa generates revenues from payments volume on its products as well as the number of transactions processed in its network.
(The Visa Network, 10-K)
As of fiscal 2016, Visa facilitated $8.2 trillion total volume of transactions including Visa Europe operations. In addition, there are 3.1 billion Visa cards worldwide as of June 2016.
(Visa’s Core Products, 10-K)
Visa has only one reportable segment, which is Payment Services. Nonetheless, Visa has the following contributing revenue parts found in its filings: service, data processing, international transaction, other revenues and client incentives.
(10-K)
Service
Service revenues consist mainly of revenues earned for services provided in support of client usage of Visa products. In fiscal 2016, services sales grew by 7.1% and contributed the largest among other Visa revenue generators at 44.7%, or $6.7 billion, in total Visa sales.
Data processing
Data processing revenues are earned for authorization, clearing, settlement, network access and other maintenance and support services that facilitate transaction and information processing among Visa’s clients globally. In 2016, the data processing business grew by 13% and contributed 41.6%, or $6.27 billion, in total Visa sales.
International transaction
International transaction revenues are earned for cross-border transaction processing and currency conversion activities. Cross-border transactions arise when the country of origin of the issuer is different from that of the merchant.
In 2016, business in international transactions grew by 14.4% and contributed 30.8%, or $4.6 billion, in total Visa sales.
Other revenues
Other revenues consist mainly of license fees for use of the Visa brand, fees for account holder services, certification and licensing and other activities related to Visa’s acquired entities. In 2016, other revenues grew flat to $823 million.
Cash, debt and book value
In 2016, Visa had $5.6 billion in cash and $15.9 billion with 0.48 times in debt-equity ratio, compared to 0 in 2015; 66.1% of Visa’s $64 billion assets are in goodwill and intangibles while having a book value of $32.9 billion, compared to $29.8 billion in 2015.
Cash flow
(10-K)
In 2015, Visa had a negative 15.3% change in its cash flow from operations to $5.57 billion. As observed, Visa has had a declining operational cash flow in recent years. One major cash flow outflow came from Visa’s client incentives. In 2015, Visa had $3.5 billion in client incentives, compared to $2.97 billion in 2014.
According to Visa, client incentives represent future cash payments for long-term contracts with financial institution clients and other Visa business partners.
Cash flow client incentives are used for various programs designed to build payments volume, increase Visa product acceptance and win merchant routing transactions (3). Payments under these arrangements will generally be offset by revenues earned from higher corresponding payments and transaction volumes.
(10-K)
Capital expenditures were $523 million, leaving Visa with $5.05 billion in free cash flow, compared to $6.17 billion in 2015. Visa allocated 168.4%, or $8.5 billion, of its free cash flow in dividends and share repurchases in 2016. This was a jump considering Visa’s previous payouts. In the recent three years, Visa had allocated an average of 103.9% of its free cash flow in payouts.
Visa also places a good amount of its cash flow in investment securities that are available for sale. These investment securities primarily include U.S. Treasury securities, U.S. government-sponsored debt securities and corporate debt securities. In 2016, Visa purchased $28 billion in investment securities while receiving $26.7 billion in proceeds from maturities and sales.
Visa also took in about $16 billion in debt in relation to its Visa Europe acquisition.
Conclusion
Based on Visa’s amazing figures and an impressive level of profitability, there would be little doubt that the company would be able to consistently deliver in the ensuing years.
Warren Buffett was also an active buyer of the company’s shares in the previous quarter. The Oracle of Omaha raised his stake in Visa by 3% owning about 10.56 million shares in the process, according to GuruFocus data.
Visa’s recent $16 billion debt intake was also understandable and still provided a good level of debt-equity balance.
(Visa Share Price at $81.8 a share with P/E (ttm) ratio at 32.9 times, GuruFocus data)
In addition to BMO’s outlook on Visa, Bank of America Merrill Lynch and Guggenheim think the company’s shares are a buy. In simple earnings multiple-based calculations, Visa has a value of $84 a share (5).
With a limited upside, Visa would be a cautious buy at an $84 per share target price.
Notes
- 10-K: the loss upon consummation of the transaction resulting from the effective settlement of the Framework Agreement between Visa and Visa Europe. The Visa Europe Framework Agreement provided Visa Europe with a perpetual, exclusive right to operate the Visa business in the Visa Europe region in exchange for a license fee paid to Visa. Under the terms of the Framework Agreement, the license fee paid by Visa Europe has increased modestly since inception in 2007, while the value of the Visa Europe business has increased at a greater rate. Using an income approach, the Company assessed the contractual terms and conditions of the Framework Agreement as compared to current market conditions and the historical and expected financial performance of Visa Europe. Based on the analysis performed, the Company determined that the terms were not at fair value as determined under U.S. GAAP at the Closing. The present value of the expected differential between payments required by the Framework Agreement and those that would be required if the contract were at fair value under U.S. GAAP was calculated over the Framework Agreement's contractual perpetual term, resulting in a loss of $1.9 billion recognized within operating expense in the company's consolidated statement of operations during the third quarter of fiscal 2016, and a reduction to the purchase accounting consideration.
- Morningstar data.
- 10-K: These agreements, which range in terms from one to 16 years, can provide card issuance and/or conversion support, volume/growth targets and marketing and program support based on specific performance requirements.
- Me: Information moving forward are gathered from Visa’s 10-K and 10-Q unless specified.
- Me: five-year P/E ratio average of 32.4, projected diluted EPS growth of 30% and a 20% margin.
Disclosure: I do not have shares in any of the companies mentioned.
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