With consistent sales and earnings growth, rapid dividend growth and secular growth trends in the coming decades, V is an obvious choice… but what about valuation?
Revenue and Earnings Growth
As we can see, Visa has consistently grown revenues at around 10% per year for the past decade, taking advantage of the growing market share of digital payment options over traditional methods like cash and checks.
This graph from Statista shows that digital commerce spending has grown at a compound annual growth rate of 12.83%. As we can see in Fiscal Years 2018–2021, Visa’s revenue growth has kept up fairly well with this, with the exception of the COVID crash of 2020. In their 2021 annual report, Visa cites a 2018 estimate of $18 trillion in annual cash and check consumer spending as their Total Addressable Market. Despite their leading position and blue-chip reputation, Visa still has a massive runway for growth, as over 1.7 billion individuals are without bank accounts worldwide, and digital commerce and point-of-sale systems are still by no means ubiquitous, even in “first world” countries.
As we can see, Visa has multiplied their earnings by nearly 6 times in the last decade. This is no surprise if we consider the scalability of their business model. The infrastructure behind their worldwide payment network has heavy upfront fixed costs, but once established, the costs of processing more payments are miniscule. This manifests when we compare the growth of their fixed assets to the growth of their profit. As we can see, net property and equipment doubled over the last decade, while earnings multiplied 6x. The nature of Visa’s business is one of increasing efficiency and profit margins as it’s client base grows. This is a main reason why Visa is a “set it and forget it” stock that we can be confident owning for an extended timeframe.
Balance Sheet // Debt Position
Like many companies, Visa took advantage of the abundant liquidity and low interest rates over the last few years. They added around 50% to their debt load in FY 2020, during the peak of Quantitative Easing. Fortunately, they maintain a strong cash position relative to debt. Adding in their accounts receivable puts their total current assets well above their total debt. For this reason, there is little concern to be had about Visa’s debt long term. However, there are several factors that could mean bad news in the short term. Recent inflation and other recessionary signals have caused a lot of fear among investors and consumers. The bears were proven right on the 29th of April, when it was revealed that U.S. GDP decreased at 1.4% year-over-year rate in the first quarter of 2022. A recession means less commerce taking place, and less transactions for Visa to skim fees off of. Because of Visa’s blue-chip status and AA- credit rating, the majority of their debt is likely fixed-rate. But, any variable-rate debts could become burdensome as the Fed enacts their series of planned rate hikes. Overall, indebtedness and other balance sheet topics are of little concern. But being a transaction intermediary means that Visa will tumble in a recession.
The above image shows us the upward long term trend in Visa’s free cash flow. Free Cash Flow is the cash that is left over after capital expenditures, operating expenses, issuance and repayment of debt, and stock buybacks. This is the cash that is used to pay dividends. This strong free cash flow growth makes sense given the highly scalable business model we discussed earlier. As we shall see, Visa has made itself a strong candidate for dividend growth portfolios in the last decade.
Buybacks and Dividends
As we can see, Visa has reduced their outstanding shares by more than one fifth in just the last decade. For those unaware, share buybacks are (generally) a positive because after a buyback, each remaining share represents a larger portion of the business and will generally grow in price accordingly.
Seeking Alpha tells us everything we need to know about Visa’s rapid dividend growth. Despite growing dividends at 17% per year for the last 5 years, they maintain a low payout ratio of just 21%. This means that only 21% of Visa’s profits were used to pay dividends in 2021. The lower the payout ratio, the better, because it means future dividend increases will not eat too heavily into profit. Also, should total profit decrease, there will still be plenty left to cover dividends.
The two main metrics I chose to look at for profitability were Free Cash Flow margin, as well as Returns on Total Capital. Free Cash Flow margin tells us what percentage of revenue was left over, after all expenses, to be returned to the shareholders. As we can see, Visa’s FCF margin rarely dips below 40%. This is powerful. It means that for every dollar the company brings in as revenue, 40 cents are available for the shareholders as dividends.
Finally, we will talk about Return on Total Capital. Return on total capital is Net Income (Profit) divided by (Debt + Equity). This answers the question, for every dollar of capital the company has available to use (debt+equity), how much do they make in profit? 15% returns on capital are considered excellent, and Visa has consistently beat that target.
Nearly everything I’ve said thus far has been positive. But we still would like to buy Visa at a fair price.
As we can see, Visa’s current P/E ratio does not scream buy when compared to history. Based on relative valuation alone, we would like the stock to drop a little lower, which I think is certainly possible should the recession continue. Now would be a good time to start dollar-cost-averaging and capture some of the downside.