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While Growth is Impressive, Visa Stock’s Valuation is at a Peak

Visa (NYSE:V) reported stellar profits on Jan. 31 for its first quarter ending December, up 10%. Its free cash flow (FCF) was even more impressive. Visa stock should do well this year if that performance keeps up.

While Growth is Impressive, Visa Stock's Valuation is at a Peak
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Moreover, Visa reported that its total payment transactions rose 11% over last year. This is a significant driver of its revenue growth. On a constant currency basis, net revenues were up 11%.

Payment transactions and volume drive revenue. Why? Visa gets a set payment for each transaction and a percentage of the dollar amount of the transaction. That totaled $3 trillion in the period, a record for the company.

Higher consumer spending drives its overall transaction and payment volume growth. As long as the U.S. and the world do not fall into a recession, this kind of growth should continue.

Meanwhile, Visa is planning sweeping changes to its swipe fees which will result in higher rates for transactions on e-commerce sites, while retailers in real estate and education, will see declines, Bloomberg reported this morning.

FCF Also Up Significantly

Visa’s quarterly FCF was up over 17% this quarter over last year. It generated $3.68 billion in FCF vs. $3.14 billion last year.

FCF is a much better measure of the company’s profits since it takes into account capex and working capital changes. These are huge uses of the company’s cash flow which net income does not measure.

Visa used its FCF to repurchase shares and pay its dividend. So far this year Visa spent $2.34 billion on share repurchases. They bought back 13 million shares. This both push up Visa stock and increased its earnings per share.

In fact, Visa has repurchased so many shares in the past year, its earnings per share rose faster than net income. Visa’s EPS was up 12% year-over-year vs. net income up 10%.

This was solely due to its share buybacks. This is because Visa’s shares outstanding are now lower by 2% from a year ago. Visa also approved an additional $9.5 billion in share repurchases over the next year, 2.2% of Visa’s current $445 billion market cap. So its buybacks will continue to help earnings per share growth.

Outlook For Earnings

Visa said it expects revenue for its fiscal year 2020 ending September to grow in the “low double digits.” That means 10 or 11%, just like it did this past quarter.

More importantly, Visa expects its earnings per share to rise in the mid-teens. Last fiscal year Visa’s EPS was $5.32. Analysts are expecting $6.17 per share. for this year, up 16%.

That puts the stock on a price-to-earnings valuation of 33 times. That is rich. This multiple is twice the expected earnings per share growth rate. Visa has to perform perfectly to live up to that kind of valuation. Any hiccups in the growth rate will have a huge impact.

But the truth is that analysts expect this kind of growth in the following year as well. That puts VISA on a P/E of 28 times for the year ending 2021, according to Seeking Alpha.

So the market expects perfect growth and prices Visa stock for this growth rate to continue.

Risks to Growth Rate

So far Visa says that it is too early to assess the threat from the Chinese coronavirus on its growth. International transaction revenue is about a third of its total net revenues.

But overall, international revenue of $3.3 billion this past quarter accounts for a little over 51% of its total $6 billion in net revenues. Visa does not break out its China numbers.

On the quarter-end conference call, management said it was expecting declines because planes are being halted in and out of China. In addition, companies are telling their employees to stay home. Visa clearly expects an impact but they didn’t want to asses the impact yet.

I suspect that this is going to be a risk to Visa’s growth rate, especially if the virus outbreak continues to grow. This is likely to have a dampening effect on Visa stock if it continues to spread.

Leveraged Effect of Risk on Visa Stock Valuation

As pointed out above, Visa’s P/E ratio is highly leveraged to the company’s growth rates in earnings per share.

For example, if earnings grew 10% less fast than expected, such as a 14.4% growth rate instead of 16%, Visa’s P/E ratio would fall faster. The P/E ratio would fall 20% to 26 times earnings instead of 33 times as it is today.

So in this example, Visa’s EPS would rise to $6.08, instead of $6.17, as expected. But the stock might fall to $158.08, or 26 times earnings. That would represent a 20% hit to Visa’s stock price.

So be on the lookout to see if there will be a continued impact on Visa’s international revenue from the virus outbreak. It could affect the stock’s priced-for-growth stock price.

As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review hereThe Guide focuses on high total yield value stocks. Subscribers a two-week free trial.

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