A 20% Upside For Visa

March 13, 2012  |  about: V 

When the marketing department created the company's most recent slogan, "More People Go With Visa," they may have been trying to give investors a message. Visa (V) is the worlds leading credit and debit card payment processor, with 392 million cards circulating worldwide carrying the Visa logo. Visa operates around the world in more than 200 countries, and according to company statistics, processes over 10,000 transactions per second.

Payment processing companies have been under fire for some time over the Durbin amendment which set limits on the interchange fees charged by the company. Regardless, the company executives have maneuvered the waters carefully and have preserved the company's profitability.

Looking forward, analysts covering the stock have the company growing earnings over the next 5 years at a 19% clip. While I see the company benefiting as the world continues to recover from a deep global recession, I am always more conservative with my estimates. For my analysis, I'll use a 13% growth rate over the next 5 years and then a stable 7% for the years after. Remaining on the conservative side, I assume that while the company has managed expenses very effectively, the long run cost of goods sold will be slightly higher then the past year at 15.5% from 15.2% in 2011.

Furthermore, now that the company has addressed many of the obligations it had with regards to pending lawsuits, I believe the company will have operating expenses going forward on average of 30.1%. Finally, despite recent proposals by politicians promising to lower corporate tax rates in exchange for closing loopholes, I will maintain the company's expected tax rate of 41% going forward. It should be noted that any change in the tax code which swaps a lower corporate tax rate for the closing of existing loopholes should greatly benefit Visa, but is not included in this analysis.

Finally, while the company has no debt on its books, I've used a weighted cost of capital for discounting future earnings of 9%. This number is always highly suspect in any earnings analysis, however, I've used the approximate average yield to maturity [YTM] for the industry leaders--MasterCard (MA), American Express, and Discover Financial Services (DFS)--of 5%, and also took into consideration the stock's 1.83 beta relative to the S&P 500. It is important to note that the 5% YTM is skewed higher by outstanding bonds for Discover Financial. American Express and MasterCard bonds have average YTM's closer to 3%, however, once again, I'll always err on the side of caution, especially on such a subjective input. After all, as the saying goes, garbage in, garbage out.

Once the number crunching is finished, what remains is an estimate for the stocks fair value based on a discounted cash flow. The result, $140/share, which is an approximate 20% premium relative to the current price of $117.17. Since the company recently reported earnings, which I might note were exceptional given decreased transaction volume, the current implied volatility it about 20% lower than historical volatility, allowing investors to go long call options at lower premiums. That being said, on the flip side, the options will not be as beneficial if you are looking to use them in a hedged position.

By Joseph Poma

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in (V) over the next 72 hours.