by Tom Taulli | August 1, 2013 10:51 am
Yesterday, Visa (V) posted the biggest fall in two years, plunging about 6%. The reason: A federal court judge ruled that the Federal Reserve had no authority to set the limits on debit card fees.
While it was a major setback, Visa has still been a big winner for the past year, posting returns of about 38% since last July. In fact, the stock has averaged that 38% gain for the past three years.
But is Visa’s growth a strong enough reason for you to buy the stock, or should the regulatory pressures keep investors at bay? To see, here’s the look at the pros and cons:
The Network: Visa has the world’s largest network, VisaNet. Its distribution footprint includes 2.1 billion cards and relationships with over 36 million merchant locations. In fact, the network can process 24,000 transactions per second! But it’s about more than scale. Visa has also invested in security and risk management solutions, and has become one of the world’s most trusted brands as a result.
Mobile Commerce: Five years ago, this market was nonexistent. But with the introduction of smartphones from Apple (AAPL) and Samsung, m-commerce is now generating transaction volumes of tens of billions. Visa has been investing aggressively in the space, with particular focus on its V.me digital wallet — a secure system that supports all major card types and allows for customization of consumer preferences. It certainly helps that Visa can leverage its massive infrastructure and cardholder base. The company forged a partnership with Starbucks (SBUX) to create a payments app that has attracted millions of users. Acquisitions and investments are another key part of the strategy. Perhaps one of Visa’s smartest deals was equity financing for Square, which is the leader in smartphone/tablet-based point-of-service solutions and now has more than 4 million merchants.
Shareholder Focus: Visa is definitely shareholder friendly. But that’s not entirely surprising from a company with such a mouthwatering business model. Visa’s net operating margins are a staggering 60%, with more than $8 billion in cash. It announced a $1.75 billion buyback plan in February, after a $1.5 billion plan in October, and has returned a total $15 billion to shareholders since 2008.
Regulations: Companies like Visa face substantial regulations — the “Risk Factors” in Visa’s 10-K run several pages long. For the most part, the limits on fees from Dodd-Frank has had adverse impact on the company’s business. And what about the ruling about the Federal Reserve? The case involves the major credit cards against retailers, who have been pushing back on interchange charges. Keep in mind that the cap for the Federal Reserve was 24 cents versus 12 cents underDodd-Frank. In other words, if the legislation prevails, there will inevitably be pressure on margins, at least in the U.S. However, there’s a good chance the decision will be appealed and there may not be an ultimate ruling until next year.
Competition: Visa must fend off MasterCard (MA) and American Express (AXP), which both have a tremendous amount of resources and global brands. But Discover (DFS) has also been gaining momentum and could be another problem for the company. At the same time, Visa needs to keep ahead of upstart operators, such as eBay’s (EBAY) PayPal, which has become a key part of the online financial landscape. Plus, there are other non-financial companies that may become threats, such as Apple (AAPL), Google (GOOG) and even Facebook (FB), all of which have substantial user bases and world-class engineering teams.
Valuation: The stock’s valuation is far from cheap, with the price-to-earnings ratio at 21X. Then again, this is to be expected given the company’s strong competitive advantages and reliable growth. But if Visa were to miss on earnings — which could happen because of new regulations or pressures from rivals — the stock could be vulnerable.
The good news is that the momentum should continue for Visa. Even if there are some limits on fees, there are huge global growth opportunities. Keep in mind that about 85% of the world’s transactions are still in cash and checks. What’s more, transactions should get a boost from the hyper-growth in mobile.
While Visa’s stock price is still on the high side, it remains reasonable. Consider that MasterCard is trading at 26X and American Express’s multiple is 18X.
So, should you buy Visa? Yes — weighing all these factors, the pros outweigh the cons on the stock.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
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