Monday, August 26, 2013

Visa (V) Dividend Stock Analysis

I wanted to get this analysis out last week but I was just way too busy with work.  Today we'll take a closer look at another lower yielding but higher growing company in Visa (V).  Visa Inc. recently became a publicly traded company with FY 2008 being their first year.  Visa closed trading on August 23rd at $179.10.

Company Background (sourced from Yahoo! Finance):

Visa Inc., a payments technology company, engages in the operation of retail electronic payments network worldwide. It facilitates commerce through the transfer of value and information among financial institutions, merchants, consumers, businesses, and government entities. The company owns and operates VisaNet that provides fraud protection for consumers and assured payment for merchants. It also offers a range of payments platforms that enable credit, debit, prepaid, and cash access programs, as well as digital, mobile, and eCommerce payments for individuals, businesses and government entities. The company provides its payment platforms under the Visa, Visa Electron, Interlink, and PLUS brands. In addition, it offers risk management, issuer processing, loyalty, dispute management, value-added information, and CyberSource-branded services. Visa Inc. is headquartered in San Francisco, California.

DCF Valuation:

Analysts expect Visa to grow earnings 18.81% per year for the next five years and I've assumed they can grow at 2/3 of that, or 12.54%, for the next 5 years and continue to grow at 3.50% per year thereafter. Running these numbers through a three stage DCF analysis with a 10% discount rate yields a fair value price of $285.81. This means the shares are trading at a 37.3% premium to the discounted cash flow analysis.

Graham Number:

The Graham Number valuation method was conceived of by Benjamin Graham, the father of value investing, and calculates the maximum price one should pay for a company given the earnings and book value.  Visa earned $8.23 per share in the last twelve months and has a current book value of $41.86.  The Graham Number is calculated to be only $88.04, suggesting that V is overvalued by 103.4%.

Average High Dividend Yield:

Visa's average high dividend yield for the past 3 years is 0.98% and for the past 6 years is 0.80%.  This gives target prices of $134.17 and $164.52 respectively based on the current annual dividend of $1.32.  The dividend yield has remained very low on this great company with just a few opportunities to pick shares up with a 1.0%+ yield at purchase due to it typically commanding a large market premium since the company is growing quite rapidly.  Given the underlying growth of the company I don't expect the average high dividend yield to change much from current levels.  I'll go on and use the average of the high yields, giving $149.34 for the target entry price.  Visa is currently trading at a 19.9% premium to the average high dividend yield valuation.


 Average Low PE Ratio:

Visa's average low PE ratio for the past 3 years is 19.02 and for the past 6 years is 26.72.   This corresponds to a price per share of $144.39 and $202.81 respectively based off the analyst estimate of $7.59 per share for fiscal year 2013.  As you can tell from the low P/E averages, Visa has typically commanded a large growth premium relative to the market.  Analysts still expect high rates of growth so the premium still exists.  I'll use the average of the two giving a target entry price of $173.60.  Visa is trading at a 3.2% premium to this price.

Average Low P/S Ratio:

Visa's average low PS ratio for the past 3 years is 7.12 and for the past 6 years is 7.06.  This corresponds to a price per share of $115.64 and $114.10 respectively based off the analyst estimate for revenue growth from FY 2012 to FY 2013.  Currently, their current PS ratio is 10.00 on a trailing twelve months basis.  Both ratios are essentially the same so I'll use the average once again giving a target entry price of $114.87.  Visa is currently trading at a 55.9% premium to this price.

Dividend Discount Model:

For the DDM, I assumed that V will be able to grow dividends for the next 5 years at the analyst estimate for EPS growth of 18.81%.  After that I assumed they can continue to raise dividends for 5 years at 75% of 18.81%, or 14.10%, and in perpetuity at 3.50%.  The dividend growth rates are based off fiscal year payouts and don't necessarily correspond to quarter over quarter increases.  To calculate the value I used a discount rate of 10%.  Based on the DDM, Visa is worth $53.07, meaning it's overvalued by 237.5%.

PE Ratios:

Visa's trailing PE is 21.76 and it's forward PE is 20.12.  The PE3 based on the average earnings for the last 3 years is 43.58.  I like to see the PE3 be less than 15 which Visa is currently well over by a factor of 3.  The PE3 and PE ratios in general are so high due to the growth premium that is usually placed upon high growth companies.  Compared to it's industry, V seems to be overvalued versus AXP (18.08) and DFS (11.11) and undervalued versus MA (25.88).  All industry comparisons are on a TTM basis.  Visa's PEG for the next 5 years is currently at 1.27 which is right in line with AXP (1.29), DFS (1.19) and MA (1.28)  Based on the PEG ratio, Visa is trading on par with it's competitors.  A lower PEG ratio is better because it means you're paying less for every dollar of growth the company achieves.

Fundamentals:

Visa's gross margins for FY 2011 and FY 2012 were 80.2% and 79.5% respectively. They have averaged a 78.5% gross profit margin over the last 5 years.  Their net income margin for the same years were 39.7% and 20.6%.  Since 2008 their net income margin has averaged 28.8% with a low of 12.8% in FY 2008.  I typically like to see gross margins greater than 60% and at least higher than 40% with net income margins being 10% and at least 7%.  Both gross and net profit margins are well over my high thresholds so barring a collapse in their margins there's not much to worry about here.  Since each industry is different and allows for different margins, I feel it's prudent to compare Visa to its industry.  For FY 2012, Visa captured only 106% of the gross margin for the industry but a pretty stunning 123% of the net income margin.  While the gross margin is essentially on par with the industry, it's reassuring that their net income margin is well higher than the average.

Share Buyback:

Visa has shown a tendency to repurchase shares as a way to return cash to shareholders in their short history.  Since FY 2002, they've purchased an  absolutely ridiculous 48.7% of their shares outstanding for an average annualized decrease of 16.5%.  A good chunk of the buybacks occurred during FY 2009 and FY 2010 where they purchased 17.4% and 35.8% respectively.  Buybacks are great as long as they are purchasing shares at a value price point, otherwise they are reducing shareholder value through the buyback program.  It appears that Visa's management was very prudent in their share buyback program as they took advantage of reduced prices during the aftermath of the "Great Recession".


A negative number for the % change value means shares were bought back by the company and a positive value means the shares outstanding increased.

Dividend Analysis:

Visa is a dividend challenger with 6 consecutive years of dividend increases.  They have increased the dividend at a 50.00%, 38.21%, and 64.38% rate for the last 1, 3, and 6 year periods.   Their payout ratio based off EPS has increased since FY 2008 which has allowed the dividend to increase faster than EPS have grown and has averaged just 16.8%.  Given the 18%+ expected EPS growth rate for Visa, dividend growth investors shouldn't be disappointed with the dividend growth in the future for Visa.


Visa is a very solid cash generator.  They have very low required capital expenses which has allowed them to turn over 90% of their operating cash flow into free cash flow to the company.  Their free cash flow has grown from $116M in 2008 to $4.633B in 2012, good for a 151.4% annualized increase.  The free cash flow payout ratio has averaged only 72.8% since FY 2008 but has averaged only 13.3% over the last three fiscal years, which is about 4.0% less than the payout based on earnings.  Annual total shareholder return when accounting for buybacks plus dividends has averaged 51.2% of FCF since FY 2010.  Their FCF after dividends, i.e. Operating Cash Flow less Capex less Dividends, has grown 264.0% per year since FY 2008.  In FY 2012 they still had $4.038B in FCF after dividends were paid.


Return on Equity and Return on Capital Invested:

Visa's ROE and ROCI actually surprised me by how low they were.  They're still at solid levels, but I expected them to be higher.  Visa's ROE has averaged 9.5% since FY 2008 with ROCI essentially tracking the same as they carry very little debt on their balance sheet.  I don't necessarily look for any absolute values for ROE or ROCI but rather fairly stable or increasing levels.  Given the short history available, Visa has earned relatively stable returns but I would like to see a more consistent basis such as between FY 2009 and FY 2011.  As of FY 2012, Visa carried no debt on their balance sheet meaning that all earnings were "owed" to the equity, i.e. shareholders, and therefore have a 0 debt-to-equity ratio.  Their balance sheet is pristine and I don't expect that to change anytime soon as their operations require very low capital expenditures and almost no inventory.


Revenue and Net Income:

Since the basis of dividend growth is revenue and net income growth, we'll now look at how Visa has done on that front.  Their revenue growth since 2008 has been excellent with a 13.6% annual increase while their net income has been even better at 27.8% per year.  This has led to their net profit margin increasing over time from 12.8% to 20.6%.  Their net income margin did take a big hit in FY 2012 coming down from the lofty 30%+ levels from FY 2009-11.


Forecast:



The chart shows the historical high and low prices since 2001 and the forecast based on the average PE ratios and the expected EPS values. I have also included a forecast based off a PE ratio that is only 75% of the average low PE ratio.  I like to the look to buy at the 75% Low PE price or lower to provide for a larger margin of safety, although this price doesn't usually come around very often. In the case of  Visa, the target low PE is 22.87 and the 0.75 * PE is 17.15.  This corresponds to an entry price of $127.61 based off the expected earnings for FY 2013 of $7.59, with a 75% target price of $108.29.  Currently Visa is trading at a $70.81 premium to the 75% low PE target price and a $51.49 premium to the average PE price.  If you believe the analyst estimates are pretty close and that it will continue to trade in it's historical PE ranges, then Visa is currently undervalued by $36.77 to it's average PE price of $215.87.

Conclusion:

The average of all the valuation models gives a target entry price of $144.12 which means that Visa is currently trading at a 24.3% premium to the target entry price. I've also calculated it with the highest and lowest valuation methods thrown out.   In this case, the DCF and DDM valuations are removed and the new average is $131.46.  Visa is trading at a 36.2% premium to this price as well.

Assuming that Visa can grow their earnings and dividends at the rates that I assumed, you're looking at great  returns over the next 10 years.  In 2023, EPS would be $28.45 and slapping a PE of 20 gives a price of $568.93.  Over the next 10 years you'd also receive $35.02 in dividends for a total return of 337.21% which is good for a 12.93% annualized rate if you purchase at the current price.  If you purchase at my target entry price of $144.12, your projected 10 year total return jumps to 419.06% for an annualized return of 15.41%.  Barring another recession in the economy I don't think you'll get a chance to purchase Visa for less than $150 per share, but we can hope.  The great news for dividend growth investors is that the payout ratio would only be 19% if the assumed growth rates come to light, so dividend payments could increase even more.

According to Yahoo! Finance the 1 year target estimate is at $208.39 suggesting about 16.35% upside from Friday's close.  Morningstar has Visa rated as a 2 star stock meaning suggesting that it's trading for a premium to their fair value estimate.


According to a Nilson Report from April of this year, Visa processes over 72% of debit transactions and just under 50% of credit card transactions.  That's in terms of actual swipes, not dollars spent, which is truly amazing.  When accounting for dollars processed Visa still leads the pack although not at nearly the same levels.  The report also showed that 34% of all cards globally carried Visa's emblem.  Visa is clearly the dominant player when it comes to paying with plastic, whether it's debit or credit.  As the global economy continues to lead to a rising middle class you can still expect plenty of growth going forward.  I'm going to add two graphs from the Nilson Report highlighting the growth potential of the industry and for Visa.



There's only two real threats to Visa's dominance are their market dominance in swipes can lead to competitors trying to undercut the fees they charge to gain market share and the growth of mobile payments.  Apple (AAPL) is rumored to be working on a mobile payments system and Paypal is the current leader.  Visa is well aware of the mobile payment threat and working on their own system in order to maintain dominance.  Visa has an overwhelming lead in branded cards as well and I don't expect that to change much going forward.  I just checked my own wallet and 3 of the 5 cards I carry have the Visa logo.  The best thing about Visa's business model is that they don't actually supply the credit lines, rather they just collect a fee on every swipe of one of their cards.  This means that the overall financial health of the consumer won't affect them nearly as much as the banks and actual credit issuers.  Sure they will probably see some decline in volume due to consumers carrying larger debt loads, but there's still plenty of transactions to fulfill just the basic needs for Visa to continue on growing.

As far as a dividend growth investment, it's probably not the best company seeing as how the dividend discount model only gives a price of $53.07, despite rather high assumed dividend growth rates.  If you want to invest in Visa it's much more of a total return story.  The dividend growth will be there but I expect capital gains to far outweigh the dividends.  If you have a portion of your portfolio that you don't mind allocating to low yield/high growth stocks or to total return investing then Visa could be a great investment.

Just gut feeling says it's be a good candidate for puts given it's relation to it's fair value but it's price per share is prohibitive.  A $175 strike price put option would require $17,500 in capital to purchase if the option was executed.  Like, IBM it'd be nice for them to be added to the mini-options list, but for now they haven't.  I fully expect to purchase some shares soon as long as the price stays around current levels.

To check out more reports check out my Stock Analysis page.

What do you think about Visa as a DG investment at today's prices?  How do you think the long-term dividend growth prospects are?

13 comments:

  1. Pursuing Financial FreedomAugust 26, 2013 at 5:07 PM

    PIP, Well done on the analysis. I find myself believing the next few months will be a great opportunity for anyone with a long time horizon (15+ years) to benefit from Visa tremendously (DGI or otherwise). The business model is fantastic and the potential for continued dividend growth is in place and moving forward. I wouldn't mind if this debit fiasco causes a significant drop in both Visa and MasterCard, allowing me to load up. With no debt and no credit liability, I just can't see this business being hurt by much. But I will plan to diversify accordingly ( and by that I mean just buying both V and MA) :) Thank again for the great analysis and keep it up!

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    1. PFF,

      Even if there is a cap on fees, the growth of number of swipes is just going to continue to grow. As a market leader, Visa will still benefit. I really like that they have no tie to the actual credit lines as that is a huge liability. I think this is going to be more geared towards a total return investment at least over the next 5-10 years. As the global market matures, that's when we'll see the dividend growth power of V and MA. If only the starting yield could get better, but if it drops into the $150/160's I'll probably look to add some more.

      Thanks for stopping by!

      Delete
  2. I think Visa is a pretty interesting stock. It seems like a total return winner, but perhaps dividends are a bit more murky. The listed DDM valuation on your analysis showcases that for income investors it might not be very attractive. However V could easily sustain a DGR larger than EPS growth since the payout ratio is minute. Maybe it would be better to assume a higher DGR on par with what it has historically demonstrated?? This company seems intent on growing dividends rapidly.

    What really catches my eye with Visa is the fact it expected to grow by 18.8% with only a 21 p/e. Compare to say PG which is expected to grow by 8% on a 20 p/e. If growth estimates hold true, I think we know which one will do better total return wise. I think V might be more of a capital appreciation move and I won't judge astute investors who seek it.

    ReplyDelete
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    1. CI,

      I think the dividends and growth will be just fine but it's much more a total return stock over the next 5-10 years. At least in my opinion. I think the DGR will exceed EPS growth on the whole over the next 5-10 years as well but I already felt that using 18% DGR's in the analysis is stretching a bit. Even using the growth rates I assumed, the payout ratio would still be a crazy low 19%.

      From a total return perspective the PEG really surprised me as well. Time will tell how much they actually grow but they should do quite well as the world moves towards paying with plastic. I'm more concerned about mobile options such as Paypal or the rumored AAPL system, if those really take off that would be a threat. I think Visa is kind of in the same situation as most of the healthcare companies. The demographics and underlying long-term trend is just way too much in their favor. Only 1% of the purchases in India are through credit/debit cards. That's a potential 1 billion more people that Visa can have access too and collect fees on every swipe.

      I wanted to try and get a company that is still in a hyper growth phase and Visa seems to be a pretty conservative bet for a company that is growing as they are. I wouldn't really call it a speculative position but it's a much faster growing company so it satisfies the "gambling" itch.

      Thanks for stopping by!

      Delete
  3. I like Visa a lot as a company. The total returns are amazing and I think that there is still plenty of room for expansion, especially as more and more of the world shifts from cash to electronic payments. If I was a total return investor, I would grab up Visa in a heartbeat. As a dividend growth investor, I'm letting it be. The dividend yield isn't high enough for me to get excited. It's not even high enough for me to rationalize buying the company regardless of the low yield. But if Visa ever bumps up the yield or experiences a substantial price correction, then I may move on it.

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    1. MyFIJ,

      I'm quite bullish on V, although as a pure dividend growth investment it's not the best because the yield is just plain low. If the growth mirrors what I assumed in the analysis the YOC would only be around 3.00% in 10 years. But that is with about 16% annual growth. The problem is that V is still growing so much that even though they've have increased the dividend extremely well the yield doesn't get much of a break so you are forced to try and buy on dips to get over a 1% yield. With Syria going up, Fed taper and debt ceiling issues there's probably going to be decent chances to get in, but not at anywhere near the normal 2.5-3.0% yield level. Visa isn't for your average DG investor but I wanted to take a bit of a flyer on this one. Total return should be solid.

      Thanks for stopping by!

      Delete
  4. I would not have thought V would have been able to grow like that. Credit cards are everywhere and there are now other options as you listed (Paypal etc).

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    1. Pulling Myself Up,

      Before I really started thinking about it I wouldn't have thought so either but after doing more research on it it makes perfect sense. It's not like V or MA are limited to just the US market, although that's still only around 50% of transactions as credit/debit. The rest of the world is going to be the big driver of growth for the processors as there's far more people and potential transactions if you can penetrate into China, India, Brazil, Indonesia. You have to know going into this that it's really a total return story, leaning towards capital gains rather than dividends, at least for the next 5-10 years.

      Thanks for stopping by!

      Delete
  5. As an engineer I absolutely love the number crunching you do. The proof of your suppositions is based soundly on math. Keep it up!

    I like Visa as a stock, but for the DGI I'm not sure if I want to initiate a position. Tough call, but I'm holding for now.

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    1. Wallet Engineers,

      I have to agree that from a pure DGI strategy, Visa probably isn't the best investment because the current yield is just too low and will probably remain so for the next 5-10 years. As they say, there's more than one way to skin a cat, which is why I purchased a small position yesterday. From a total return perspective though it's pretty compelling in the long-term as more and more people globally move into the middle class and get credit/debit cards. What better way than to hitch your wagon to the market leader? Over the next 5-10 years I'll reevaluate whether it really fits in my portfolio. As for now though they do pay a dividend, are growing the dividend really fast, and are growing the company really fast. Lots to like here. No debt and low capex (~11% of Oper. cash flow) means that 80-90% of OCF could be returned each year to shareholders.

      I really like crunching the numbers because it's a very black and white matter either this happened or it didn't. Now granted it doesn't mean they will repeat in the future but that's why I like to use some forward looking valuation methods, DCF and DDM, using conservative growth estimates. But it's still important to look at the overall story of the company. I wouldn't invest in a newspaper right now, no matter what the yield. Owning the best company in a dying industry won't turn out too well and will just delay the inevitable.

      What kind of engineer are you? I graduated with a civil engineering degree and used it for 1.5 years, but no longer do as I now work in the oilfield.

      Thanks for stopping by!

      Delete
  6. Nice analysis. Visa is one of my core holdings alongside McDonalds and Coca Cola that I'm expecting to never sell. I bought into Mastercard at the IPO, I was so bullish on the sector, I have owned and sold this over time, but have a core holding in Visa and Mastercard that are up greater than 50%. I do take a selective amount of positions in companies that just have such great business models that I want to hold them forever. I'm hard pressed to justify Visa or Mastercard as DGI stocks, but I like these businesses so much that I'll let them slide. I imagine that eventually in 20-30 years, I'll have a reasonable dividend stream from both companies, but that the positions would have generated significant capital growth in that time.

    Wide moats, heavily used product, incredible barriers to entry.....whats not to like?

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    1. Integrator,

      I think Visa makes for a solid core holding, although as you mention it's probably not going to be the best pure DG stock because the starting yield is so low. As long as the core of my portfolio remains DG then I think it's fine to take a bit more of a total return approach with some of the capital, especially since I believe there's just so much growth for V and MA. I need to take a closer look at MA as well.

      Not only are they great for the reasons you mentioned, but the growth potential on a global scale is pretty enormous. 1% of the retail transactions in India are processed as credit/debit. Even just getting to the 30% rate is going to mean big money for V and MA because the scale is outrageous. There's over 1 billion people in India. If you just extrapolate current market shares to the Indian market alone, that's like adding a second US at least from the market size.

      How do you feel about American Express and Discover? They actually do provide the credit lines so I think there's more risk involved there.

      Thanks for stopping by!

      Delete
  7. As of November 11, 2013, Visa’s stock is up almost 30% year-to-date (YTD) but has underperformed its primary competitors #MasterCard, American Express and Discover, which are up 48%, 42% and 36% YTD respectively. The stock has also outperformed the XLF, which is the S&P Financials Select Sector SPDR® exchange-traded fund (ETF). This is not surprising, as card companies have experienced accelerated revenue and earnings growth in the past couple of years, and generally have a better outlook than most other financials, given the steadily recovering retail environment and higher consumer spending in the economy. Visa’s stock price was $199 on November 11, 2013.http://goo.gl/5HOiGA

    ReplyDelete