It’s not often a company like Visa comes around. Visa is a relatively new public company, despite being in existence for almost 50 years and being one of the biggest brand names in the world. At the time, its 2008 IPO was the largest IPO in US history.
It’s one of those companies that always seems like it’s overvalued because it’s always trading at a high P/E multiple. Early in my investment days I looked at the high P/E and the low dividend yield and dismissed it as an investment. In doing so I learned an important lesson. Sometimes high quality companies deserve to trade at high valuations.
A general rule I follow is that it is almost impossible to maintain high-teens to low-twenty percent EPS growth over a long period of time. People see that kind of profit growth and they want a piece. It’s the nature of most financial systems. Be it competition or regulation, there is always someone or something coming for you when you are making money hand over fist.
And for the past decade, Visa has been making money hand over fist. They’ve grown EPS 19% annually over the past decade. That is an incredibly impressive number. You’d be hard pressed to find any company with that kind of earnings growth over 10 years, much less a company the size of Visa. So how is Visa able to produce those impressive earnings? It has the impressive trifecta of high barriers to entry, low operating cost and, the real gem, built in inflation protection.
The payment processing industry is not a very crowded place. Visa, MasterCard, Discover and American Express virtually run the show. PayPal and a slew of startups are trying to break the business model, but have not had much success in taking share from the big 4. People love the convenience and rewards that come with major credit cards.
The reason it is unlikely any another players will surface in the transaction processing space in the near term is twofold. Building out a payment processing network is not cheap. A startup can’t just come in tomorrow and build a processing network with the coverage and robustness of the big 4. Perhaps more importantly, retail owners don’t want new players. They are already peeved enough about the 3% processing fees they have to pay to Visa and the like. In fact many major retailers have tried to create their own form of payment processing to get away from those 3% fees. To date, they’ve struggled with adoption. See the bold sentence from the last paragraph to guess why.
While building out a payment processing network is costly, once it is deployed ongoing maintenance costs are very low. Think of it like any other computer network. Once everything is up and running, electricity is the main cost. Hardware upgrades do have to be made periodically, but they tend to not overly damaging to the bottom line.
Built in inflation protection is hard to find. Inflation is the natural fall of the purchasing value of a dollar and the resulting need to increase prices to realize the same economic value. It’s the reason why your favorite fast food joints seem to slowly get more and more expensive. If you’ve ever heard someone say back in my day everything was so much cheaper… Well, that’s normal. Over time everything will naturally get more expensive in an inflationary economy (which is generally any economy where more money is added to the money supply over time) . It doesn’t mean it “costs more to live” today.
The kicker to inflation is all businesses have to raise prices over time to remain profitable. Raising prices comes with the risk of decreasing sales. The price/demand question is something all business have to deal with. They want to maximum price without impacting sales. It can be a tricky tight rope to walk (I’m curious as to how Netflix customers are going to respond to their announced price raise for example).
Visa is in the enviable portion of not having to worry about walking that tight rope. Their fee is a % of each transaction. They get to take full advantage of inflation without being exposed to price raise risk. If McDonalds raises prices on their menu items, Visa’s profits go up. Oil prices go up? So does Visa’s bottom line. As the world’s economy grows, so does Visa. The awesome part is Visa doesn’t have to do anything!
I oversimplified that last piece a bit – Visa does need to spend money to keep their network humming and they do need to stay on top of what their competitors and the industry innovators are doing. But the general concept stands.
The relatively low amount of money Visa has to spend on infrastructure and R&D means it has more money to spend on acquisitions and shareholder returns. It has been quite aggressive on both of those fronts since going public. It recently acquired Visa Europe in a major deal which has only added to their growth. It also is able to retire about 2.5% of its shares outstanding every year, meaning shares you buy now, will represent a larger portion of the company as time goes on. Visa pays a small dividend as well (only a 0.8% yield as of now), though it has been aggressive in increasing the payment. While not a true income play now, it certainly has the potential to be one in the future, as it has doubled is dividend in the past 3 years. If it is able to keep the pace, which will depend on if it can continue to grow earnings like it has in the past, 6 years from now that 0.8% starting yield become a 3% yield on the cost of your investment. Not too shabby.
Visa’s incredible past performance and resilient business model make me confident that it can continue its extraordinary performance going forward. And it’s the reason Visa is on a very short list of companies I think is a good value buy anytime its P/E is 30 or below. Even if Visa is unable to replicate its performance from the last decade – and I think something close to 12% annual EPS growth down from 19% should be expected – it still has a bright future ahead.