In this environment, Visa Inc. (NYSE:V) continues to produce excellent results, demonstrating once more how effective it is as an inflation hedge. Additionally, Visa recently increased both its share repurchase program and dividend by an impressive 20%. Although Visa stock is not particularly cheap per se, given its quality, growth, and historical valuation norm, Visa is a good investment.
Excellent Fourth Quarter Results for Visa
In November, Visa Inc. released its most recent quarterly results. Revenues for the company’s fiscal fourth quarter increased by 19% year over year to $7.8 billion. Even better, the company outperformed expectations once more, as it has every quarter for the past two years.
Although one might think they should have learned from past mistakes, Wall Street analysts still underestimate the company. But since that benefits investors, I’m pleased with Visa’s ongoing performance above what analysts predict each quarter.
With $1.93 in earnings per share, Visa outperformed expectations regarding its bottom-line performance. Visa beat revenue estimates by 3%, which explains some of that. However, Visa also produced a higher profit margin than Wall Street had predicted. Although Visa has maintained excellent margins for many years, the business still finds ways to increase its margins from a high base.
Visa Benefits From Inflation
Visa, a provider of payment technology, retains a portion of each transaction that cardholders of its cards make. When inflation increases consumer spending on goods like groceries, gas, and other items, Visa profits because it takes a steady percentage of the increased payment, many other businesses experience higher inflation, particularly when their costs increase due to rising labor, transportation, and other expenses.
However, because Visa is a business where these costs are low, its own costs remain relatively high. Visa does not need to move anything from point A to point B, so it is not subject to increased charges brought on by, say, rising diesel prices. Since Visa’s business isn’t labor-intensive, increased employee costs won’t significantly impact Visa. Since Visa does not engage in the business of selling goods, it is not impacted by rising manufacturing input costs.
While retailers like Target (NYSE:TGT), Walmart (NYSE:WMT), and Amazon (NASDAQ:AMZN) struggle with rising energy costs at their facilities, rising diesel prices that affect their transportation costs, rising labor costs, and rising purchase prices for the products they sell, Visa is content to take a bigger cut of all consumer spending that increases due to inflation. In contrast, its own costs do not increase significantly. This explains how Visa, whose net profit margin was already very high, could still increase its margins during the most recent quarter.
In other words, Visa is a great inflation play because its revenue increases due to price increases. There are additional factors driving revenue growth, but we’ll get to those later. This sets Visa apart from many other businesses that struggle due to high inflation rates’ negative effects on their costs.
This resistance to inflation is a huge advantage for Visa in the current environment, where inflation rates are at 40-year highs in many economies, including the US. I don’t think it’s a coincidence that over the past year, Visa’s shares have increased by 7% while the S&P 500 index has decreased by roughly 13%; Visa’s strong positioning in the current market explains its significant outperformance versus the overall market, where many businesses struggle.
Lots of Room for Growth
The current macro theme of inflation benefits Visa, but additional growth tailwinds are also in place. Even if inflation were to return to 2% in the near future, which is not guaranteed, Visa would probably continue to produce impressive business growth, particularly in terms of growth in earnings per share.
Visa first gains from network expansion. Consumers all over the world are choosing non-cash payments more and more. Although many consumers in the US already use credit cards, there is more room for growth in other markets. Therefore, it’s highly likely that Visa will be able to increase the number of users on its network over time, with international expansion accounting for most of that increase.
Innovations like Apple Pay, which enables users to use their credit cards in conjunction with their phones, are likely to shift consumer spending further away from cash in favor of non-cash purchases, enabling Visa to capture a larger share of the market gradually.
Even in a fictitious world without inflation, consumer spending would rise over time. Even though the growth rate is not very high, consumer spending is still increasing over the long term in real terms, which benefits Visa’s ability to grow its revenue.
Additionally, Visa benefits from international travel. Travel will probably resume once the pandemic is over, especially after China lifts its restrictions (the timing of that is not certain, of course). Long-term megatrends like growing travel are evident in data like the following:
Although the likelihood of each of these predictions varies, it is undeniable that the trend is upward. More people will be able to travel for leisure as wealth levels rise in developing nations, and as the world becomes more connected, this should also positively affect travel. People use their credit cards more frequently when traveling abroad because it eliminates the need to carry cash in a foreign currency. Growing travel is a long-term tailwind for Visa because it has a higher take rate on “international” or cross-border revenue (and other credit card companies).
Because of its highly competitive gross margin of more than 80%, Visa’s business model has low proportional costs. Because operating expenses do not increase significantly due to an increase in revenue, Visa typically enjoys operating leverage, which means that over time, its profits will grow faster than its revenue.
Due to the impact of share repurchases, the higher growth rate for earnings per share compared to revenue growth or business growth is more obvious. Visa has been repurchasing shares for many years and will keep doing so. The business just disclosed a new $12 billion buyback authorization. As a result of those buybacks, Visa’s share count is gradually reduced, and each remaining share eventually receives a larger share of the company’s overall profits. Because Visa is repurchasing about 2% of its shares annually (actual reduction rate, i.e. accounting for shares issued to employees and management), we predict that EPS growth will eventually be about 2% higher than net income growth.
Given all of these circumstances, I think there is a good chance that Visa will increase its earnings per share by at least 10% annually in the near future, and probably much more in 2023 due to the ongoing pandemic recovery (e.g. when it comes to international travel). Analysts predict the longer-term EPS growth rate to be in the range of 16%:
Although it is not guaranteed, the fact that Visa frequently outperformed analyst expectations is undoubtedly a good sign. Even if Visa’s average growth rate is well above 10% going forward, even 10% would be a respectable growth rate. In any case, the 10%+ EPS growth rate I predict will be achieved over the long term is moderate.
Visa Stock: The Valuation Is Excellent
Although a company’s quality and growth prospects are significant, investors should also always consider the stock’s market valuation. Looking at that, Visa stock appears to be priced very competitively right now.
Compared to how the company was previously valued, Visa trades at a significant discount, 25 times this year’s earnings and 22 times next year’s earnings. Using earnings per share projections for the current fiscal year, the 33x median earnings multiple over the past ten years represents a 32% premium compared to Visa’s current valuation.
Regarding its 10-year median earnings multiple, Visa does have upside potential for the upcoming fiscal year of 53%. The valuation discount becomes even more apparent when we consider the 5-year median earnings multiple.
It is debatable whether Visa will trade at the historical valuation average in the near future, but it is undeniable that the stock is currently undervalued; right now is one of the best times to purchase Visa’s shares. The current valuation seems quite reasonable, especially when we consider Visa’s strong fundamentals, like its extremely high margins and strong balance sheet, as well as the fact that buybacks are still being conducted, earnings growth is expected to continue to increase, and Visa benefits from inflation.
Bottom Line
A high-quality business, Visa has a promising future and benefits from inflation. Visa is a pretty compelling investment right now, especially when considering growing shareholder returns and a historically low valuation.
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