At the beginning of December, I wrote an article about Visa's (V, Financial) valuation, in which I concluded that the stock was starting to look cheap compared to its potential.
At the time of that article, the stock was trading at around $200 per share compared to my fair value estimate of $246 per share. I concluded that this margin of safety was wide enough to make up for the company's challenges over the next couple of years.
One of the biggest challenges I believed the company would face at the time was international transaction volumes. Cross-border spending is a significant revenue generator for the group, but after the pandemic decimated the international travel industry, volumes for the company dropped off a cliff.
Based on this, I noted previously:
"It is clear that cross-border spending will not return to 2019 levels in the next six months, but even the most pessimistic projections suggest global travel will return to 2019 levels by 2023 or 2024. This could act as a significant catalyst for the company as the amount of money it earns on each cross-border transaction is three times higher than domestic transactions."
As it turns out, I was far too conservative in my analysis.
According to the company's results for the first quarter of its 2022 financial year, cross-border transaction volumes increased 40% in the three months to the end of December compared to the prior-year period. Overall transaction volumes during the period increased by 21%. Overall, net revenues increased 24% and net income jumped 27%.
Another factor I thought was worth considering was growing competition from other digital challengers and the cryptocurrency sector. I thought this might have an impact on profit margins.
As it turns out, excluding litigation expenses, the company's operating profit margin actually increased slightly in the first quarter of its fiscal 2022 financial year compared to the prior year, suggesting competition isn't negatively affecting the company's profitability.
I will be the first to admit that just one quarter of data is not really enough on which to base a long-term decision. Nor do I think it is particularly sensible to update valuation models every couple of months. However, in the current fast-paced environment, when the outlook for the global economy is changing almost every month, I do not think it is unreasonable to go back and take a look at models if the underlying fundamentals have changed significantly, as I believe they have done in this case.
Previously, I was using a 4% discount rate and a terminal free cash flow growth rate of 10% per annum to value the business in a discounted cash flow analysis. Using the same figures today in the Gurufocus DCF valuation calculator gives a fair value estimate of $259 per share, an increase of 5% from my previous fair value estimate based on the company's higher historical cash flow generation.
In the current interest rate environment, one could argue that a discount rate of 4% is too conservative. A discount rate of 6% gives a fair value of $206, but I also am considering the fact that the company's cash flow growth is coming in far above expectations.
Increasing the terminal cash flow growth rate to 15%, which is still below the 10-year average of 19%, throws up a fair value estimate of $358 per share, even with the higher discount rate of 6%.
The challenges that Visa faces still apply, but over the past couple of weeks, it has become clear that the company has recovered much faster from the pandemic than I initially expected. My revised valuation models take this faster-than-expected recovery into account and show that the company's fair value has increased as a result.
