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.
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.
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.
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%.
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.
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.
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.
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.
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.
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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?