Visa: Continuing Recovery Brings Double-Digit Annualised Return

Introduction

We review Visa (V) (Buy-rated in our coverage) ahead of FY20 results on October 28, referencing last quarter’s results, recent volume data and management comments.

Since our initial Buy rating in June 2019, Visa shares have returned 25.3% (including dividends), slightly ahead of the S&P 500, behind Mastercard (MA) (Buy-rated) and PayPal (PYPL) (also Buy-rated), but far ahead of American Express (AXP) (Neutral-rated):

Stable Year-on-Year Volume Trends

The last set of Visa volume data was for August, which showed stable year-on-year trends in U.S. payments, with a 7% year-on-year growth (8% in July):

Debit card volume continues to lead the recovery, partly due to consumers using their debit cards in purchases that were previously made with cash withdrawn from ATMs. The year-on-year decline in Card Present decelerated slightly in late August, but volume was still down high-single-digits. Card Not Present (Excluding Travel) volume remained at 30% higher year-on-year.

Outside the U.S., “the majority of international markets exhibited a similar trajectory as the U.S. in August.”

Visa volumes were slightly better than those of Mastercard, whose global switched volumes were 2-3% higher year-on-year, including U.S. volumes at 4-5% higher and non-U.S. volumes roughly flat. Visa was helped by federal stimulus payments and unemployment benefits in 20 states being paid through its cards, which lifted its Debit volume growth in May and June by “several points.” (Visa also has historically had a slightly higher mix of Debit in its U.S. volume, at 53.5% in CY19, vs. 51.0% at Mastercard.)

Likely Quick Recovery in Cross-Border after COVID-19

High-margin cross-border volumes have shown little improvement since June, due to international travel still being largely absent. Travel cross-border volume was down 78% year-on-year for Q3 FY20, including down 70% for June, and has changed little since. As Visa said in its filing, “since May, cross-border volume growth excluding intra-Europe transactions has essentially remained at the same level”:

Visa Cross-Border Volume Growth Y/Y (Jun-Aug 2020)

Source: Visa 8-K filing (01-Sep-20).

Non-travel cross-border e-commerce has been growing strongly, with the “Card Not Present, Excluding Travel” part of cross-border volume being consistently up 20% year-on-year, but this was not enough to offset the overall decline, as it was only about one third of total cross-border volumes before COVID-19.

We believe Visa’s cross-border volumes will recover quickly after the COVID-19 outbreak. There have been examples of rapid recoveries in travel where borders have been re-opened (U.S.-Mexico, intra-EU, Turkey). As Visa’s head of investor relations said at a conference in early September:

“On the earnings call we highlighted, for example, travel from the U.S. to Mexico and the Caribbean, as those markets opened up, within six to eight weeks we saw 40-point improvements in the year-over-year performance. And we were seeing the same things with travel within Europe where a lot of the borders are opened. And the most recent example of that is in Turkey”

Mike Milotich, Visa SVP, Investor Relations (KeyBanc conference, September 9, 2020)

While the COVID-19 outbreak has worsened in recent weeks, we believe consumer travel will recover quickly once the outbreak is over because of the natural human desire to travel. We do think there is a risk of a permanent reduction in business travel, but Visa’s exposure to this is low. Before COVID-19, Visa’s total volume mix is 88% consumer and 12% business, and its cross-border volume was even more weighted towards consumer.

Volume Mix Shift Neutral to Positive

With the significant shift in volume mix towards more Debit and more Card Not Present as a result of COVID-19, management has on several occasions reassured investors that this will be neutral to Visa’s fee margins:

“(Between Credit and Debit) there are some modest yield differences depending on parts of the world and so on. I don’t think you should view that as a huge factor.”

Vasant Prabhu, Visa Vice Chairman & CFO (Q3 FY20 earnings call)

(Between Credit and Debit) we really are quite indifferent between which product is coming across. It’s not a big driver of difference … a thing that drives credit yields down is there’s more concentration amongst the big credit issuers. And so there’s a bit more pressure on yield in that side. However, on the debit side, we have to win the transaction twice, given the Durbin Amendment.“

Oliver Jenkyn, Visa EVP & Regional President, North America (Deutsche Bank conference, September 15, 2020)

“(On Visa’s economics in a card-not-present versus card-present transaction) There’s always nuances, of course, local nuances. But in general terms, our pricing is no different.”

Mike Milotich, Visa SVP, Investor Relations (Autonomous conference, September 17, 2020)

Similarly, while contactless payment has shown strong growth, management stated Visa would be “indifferent” to whether this was done through cards or mobile devices. (Cards are currently ahead in both the U.S. and key markets.)

The mix shift can also be positive to revenues indirectly, as the newer channels like online tend to provide more opportunities for Visa to sell value-add services (such as anti-fraud offerings) to customers.

Datapoints for Digital Acceleration

As with other payment providers, Visa has seen an acceleration in the move to digital payments and believes the impact is likely to be permanent. Management has provided several Visa datapoints to support this view:

  • U.S. credentials active in e-commerce excluding travel was up 12% from January to June of 2020; per-credential spend was up more than 6%.
  • 80m contactless cards have been added in the U.S. during H1 CY20, bringing the total to 200m; this will be 300m by CY20 year-end.
  • U.S. peer-to-peer volume was up 80% year-on-year in Q3 FY20; Visa Direct (B2B and B2C) global transactions were up mid-60% year-on-year.

Q3 FY20 Results

Q3 FY20 (April to June of 2020) would likely prove the worst quarter in volumes and provides a good indication of where earnings would trough. For the quarter, Visa’s Payment Volume was down 9.9% year-on-year globally (excluding currency) and down 7.0% in the U.S.:

Visa’s P&L is shown below. The volume decline above translated into a 17% year-on-year overall revenue decline in Q3, including:

  • Service Revenues were flat (+0.2%) year-on-year in Q3, as they are reported with a 1-quarter lag; otherwise they would have been down 11% year-on-year, and total revenues would have been down 21.5%.
  • International Transaction Revenues were down 44% year-on-year, due to the 38% decline in cross-border volumes described above.
  • Other Revenues were down 8%, due to some value-add services being used less by customers during COVID-19.

Overall value-add services revenues were in fact up mid-teens year-on-year in Q3, but the volume-based part of these revenues are reported in different revenue lines – approximately two thirds of value-add services revenues are in Data Processing and one-sixth are in Service Revenues; only one sixth are in Other Revenues. The business lines in Other Revenues that were impacted by COVID-19 included travel-related card benefits and marketing services; Visa also waived some fees as a result of the outbreak.

Visa Key P&L Items (Q3 & Year-to-Date FY20)

NB. Figures are non-GAAP unless otherwise stated. Differences between GAAP and non-GAAP figures include litigation, charitable donation & tax matters.

Source: Visa results press release (Q3 FY20).

Visa cut its expenses by 5.7% year-on-year (7% excluding currency) in Q3 FY20, but EBIT was still down 22.8% year-on-year, and EPS was down 21% (excluding currency). Expense reductions were mostly in Marketing, Professional Fees and General & Administrative; management stated that investments were not affected:

Visa Operating Expenses (Q3 & Year-to-Date FY20)

Source: Visa results press release (Q3 FY20).

FY20 Outlook

Management has not provided an FY20 outlook, due to the uncertainties on COVID-19 and the economy, but commented for Q4 that:

  • Cross-border volume excluding intra-Europe will be “the most important variable” for Q4 revenues.
  • Service Revenues will be lower in Q4 than Q3, unless business drivers change, due to the lagging effect of volume declines described above.
  • Non-GAAP expenses are likely to have “roughly” the same year-on-year decline in Q4 as in Q3.

We believe these mean that Q4 FY20 Service Revenues are likely to be 10% lower year-on-year, and International Transaction Revenue will likely still be more than 40% lower, which means total revenues will likely be 15% lower – a similar decline to that in Q3.

Valuation

At $202.47, on pre-COVID-19 CY19 financials, Visa is trading at a 35.4x P/E and a 2.7% Free Cash Flow (“FCF”) Yield:

Visa Net Income, Cashflows & Valuation (FY16-CY19)

NB. Visa Europe acquired in Jun-16. Source: Visa company filings.

The Dividend Yield is 0.6% ($1.20). Visa has maintained its dividend at $0.30 per quarter and continued its share repurchases, buying back $900m of shares at an average price of $180.47 during Q3 FY20.

By comparison, Mastercard is trading at a 43.7x P/E and a 2.1% FCF Yield (also on 2019 financials), and has a 0.5% Dividend Yield, maintaining its longstanding premium over Visa.

Illustrative Return Forecasts

We have set out more explicit (but still illustrative) return forecasts below. Our key assumptions include:

  • Q4 FY20 Net Income to be 20% lower year-on-year, which means total FY20 Net Income will be 6.7% lower year-on-year.
  • FY21 Net Income to be 10% lower than FY19, reflecting weakness up to June 2021 but a recovery thereafter.
  • Thereafter Net Income to grow by 12.5% in both FY22 and FY23.
  • Share count to fall by 1.5% each year due to buybacks.
  • These imply FY22 and FY23 EPS growth of 14.2%, slightly below the mid-teens EPS growth we had expected before COVID-19.
  • Dividend at $0.30 / quarter for Q4 FY20 and then on a 22.5% payout ratio (the mid-point of management’s 20-25% target), including a flat FY21.
  • FY23 exit P/E of 40x, implying a 0.6% Dividend Yield.

At $202.47, on these assumptions, we believe shares can deliver an annualised return of 11.8% and a total return of 40% over 3.5 years

Illustrative Visa Return Forecasts

Source: Librarian Capital estimates.

Our assumed exit P/E of 40x represents a 13% upward re-rating from the current multiple), but is in line with the 42x we have assumed for Mastercard. In general, with a “lower for longer” outlook for interest rates, we expect high-quality franchises such as Visa and Mastercard to trade at premium multiples, which still compare favourably with yields on long-term government bonds.

However, if we were to assume a 35x exit P/E instead, we would still arrive at respectable figures of a 7.0% annualised return and a 22% total return.

Conclusion

Visa volume was on a stable trend through June-August, up 7-8% year-on-year in the U.S., but high-margin cross-border volume was still down 40%.

Cross-border travel has recovered quickly where borders have reopened; the mix shift to more Debit and Card Not Present is revenue-neutral.

Q3 FY20 volume was down 10% year-on-year, pushing revenues down 17% and EPS down 21%; we expect Q4 to show a similar decline.

At $202.47, with an FY21 recovery, we expect Visa shares to have an annualised return of 11.8% and total return of 40% over 3.5 years.

We reiterate our Buy rating on Visa.

Note: A track record of my past recommendations can be found here.

Disclosure: I am/we are long V,MA,PYPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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