Visa (V) is the world’s dominant credit card and payment services company. It has plenty of worthy competition. Mastercard (MA) in particular is a very strong opponent.
V stock has traded between $60 and $80 per share over the past year. It had generally been in a downtrend, hitting the high toward the end of 2015. In 2016, however, shares are off about 5% through mid March. Is now the time to buy Visa stock?
Visa Stock: Pros
High Margins: Visa is a great business. It has the lead position in an oligopoly. There are only a few companies that have reasonable market shares within the credit card business. There are massive network effects for companies like Visa. An upstart needs to get millions of cards and thousands of vendors onto its network before it can become even a niche player. New competition is virtually impossible. This is the sort of huge moat you want for long-term winning investments.
Visa has tremendous profitability. It earns a 48% profit margin, a fantastic 66% operating margin, and returns an extremely enviable 23% on equity. This is a business that simply throws off buckets of cash.
China: Visa will soon be entering the Chinese market. Until recently, China gave a monopoly to the firm UnionPay. UnionPay is simply massive. It actually recently passed Visa in overall volume of payments cleared.
Visa will have to invest heavily in China to gain any meaningful market share. UnionPay has an extremely strong position. It’s unclear if China actually will welcome competition, or if Visa’s entry is only possible due to badgering from the World Trade Organization. Even with these potential issues, the Chinese opportunity is so large that if Visa has even a modicum of success, V stock will profit handsomely.
Stealing Market Share: Back in its more established markets, Visa is also having success. The most notable of these would be its successful efforts to poach business from other peers.
Most notably, Visa managed to win over the contract with Costco (COST). They managed to grab this key contract from American Express (AXP). This event caused a big hit to American Express shares and investor confidence, while V stock benefited.
Showing it is also taking on Mastercard, Visa managed to grab the the contract for USAA from Mastercard. This contract had been held by USAA for a very long time. While the Costco deal is probably more important, this one also gives Visa a good deal of prestige. Combined, it’s a nice show of business momentum going into 2016.
Visa Stock Cons
Visa Europe: Short-Term Overhang: In the long run, Visa’s decision to bring Visa Europe into its corporate umbrella should be positive. In the short run, though, it could be a negative for V stock.
Visa Europe was a different sort of business from Visa. The big difference is that Visa Europe was operated as a membership cooperative between many different European banks. As such, the owners had motivation to maintain lower profit margins. Visa Europe was in effect selling services to a related party.
Now that, for the first time since 2007, the businesses are united again, Visa will try to streamline operations. Still the delta between the two is huge. Visa Europe earned a 27% operating margin according to its most recent annual report. Visa, on the other hand, managed a 65% operating profit margin in full year 2015. On a per transaction basis, Visa Europe made just two cents per sale, while the US company made 14 cents per transaction. Short-term effects of the merger may make Visa’s 2016 results look optically weaker and drag on V stock performance.
Technological Disruption: Visa and other credit card processors charge relatively high processing fees. Financial tech startups are abundant, as entrepreneurs try to find some way to disrupt the market. There are several categories that could bring trouble.
One would be upstart payment companies. Square (SQ) for example offers smaller merchants a route of accepting payment that bypasses the traditional credit card infrastructure. Square’s valuation came down dramatically before it finally went public in late 2015. And since then, the stock hasn’t been a star performer. However, even if Square isn’t successful, it’s shown that there is room for disruption in the space. Other players such as Apple Pay haven’t gotten off to a fast start, but remain as significant potential concerns.
On the other end of the spectrum, it’s possible something could arise from the open source world. The rising popularity of Bitcoin offers the potential for a group of users to totally avoid traditional banking and credit card companies altogether. Should rising opposition to corporatism continue, more transactions could go dark through Bitcoin and other such privacy-focused networks. Also, these tech alternatives offer the possibility of avoiding taxation and government scrutiny.
A Little Expensive: Visa stock is somewhat overpriced on traditional valuation metrics. At its 25 PE ratio, it isn’t aggressively expensive compared to a lot of the big tech stocks. However, excluding acquisitions, it really isn’t growing that quickly either. And on other ratios, V stock is more pricey. The 12x price/sales and 6x price/book ratios are really lofty. Though, these are generally offset by the company’s unusually high profit margins.
You can certainly justify paying 25x earnings for a great business. Visa is a great business. But it’s not cheap. And at a dividend yield of less than 1%, you aren’t getting paid a lot to own V stock. For a company with fat margins that grows at a moderate pace, the company could afford to pay a higher dividend yield.
Verdict
Visa is a company that is really performing well. The cons are things that are very manageable. Both the expensiveness of the stock and the short-term margins hit from Visa Europe are passing concerns. And the technology disruption appears to be far off. The pros are strong, and the company is picking up momentum.
I don’t own Visa yet. Valuation is a concern for me with V stock. But I’m eagerly watching to see how deeply this pulloff runs. This is a company that belongs in many investors’ portfolios.
At the time of this writing, Ian Bezek had no position in any stocks mentioned. You can reach him on Twitter at @irbezek.
More From InvestorPlace:
