By: Steve Smith
Shares of credit card processing firm Visa (V) have been a steady performer over the years, delivering an annualized return of 19% over the past decade. But after hitting a new all-time high of $83.80 in September the stock has rolled over to a recent low of $75 and down 1% for the year -to-date. With its 10 year long winning streak at risk, does this signal Visa’s growth has maxed out?
Visa shares have always enjoyed a fairly rich valuation, usually in the 26x-30x forward earnings thanks to its large market share, consistent double digit earnings growth and identifiable brand. But as EPS growth is expected to slow to 18% in 2017 and 13% in 2018, it may be time to reconsider whether it deserves such a premium multiple. There are certainly some secular forces at work suggesting it may never regain its prior growth rate.
The technical picture also has a negative picture as it broke major support at the $79 and is now below its 50 dma which is downward sloping.
While most other financial related businesses are rejoicing at the possibility of less regulation and potentially higher interest rates Visa seems to suffering from an increase in the former and does not benefit from the latter.
Credit card issuing banks for companies such as Capital One (COF) charge interest on outstanding balances carried by the cardholder; meaning higher rates provide larger profits. They also assume default risk.
By contrast Visa earns it revenue on a per transaction fee (AKA swipe fee), which is fixed and paid by the merchant. It has no exposure to default. But over the past few years regulations have limited the amount Visa can charge business per transaction, which reduced margins.
Visa is also facing competition from new digital payment platforms ranging from PayPal (PYPL), Apple Pay and even Bitcoin which are expected to grow even quicker along with the broader trend of online shopping.
A more specific piece of regulation came on November 2, when the Federal Reserve published a clarification of Regulation II. The regulator confirmed the set of rules prohibits all payment networks from restricting the number of networks over which debit transactions may be processed to less than two unaffiliated networks, and from inhibiting a merchant’s ability to direct the routing of a debit transaction over any network the issuer has enabled to process it.
On November 16, the National Retail Federation, the world’s largest retail trade association, called on Visa to stop using the new EMV technology to steer debit card transactions to its own processing network. According to the National Retail Federation:
“Retailers have been pressured to accept the Visa Debit/U.S. Debit screen because Visa has instructed companies that certify the installation of EMV terminals that the screen must be shown to be displayable before the terminals can be certified. Under rules unilaterally imposed by the card industry last year, retailers who do not have certified chip card readers are subject to increased liability for fraud if a chip card turns out to be counterfeit, exposing merchants to huge losses”.
Visa quickly announced changes to its debit transaction routing rules for merchants and acquirers. Firstly, the company confirmed issuers can choose to offer any number of networks in addition to Visa Debit. Secondly, Visa clarified merchants are allowed to promote their preferred payment method effectively meaning they can easily route US debit transactions to non-Visa debit networks.
The result of the new policies is Visa will lose some of its U.S. debit market share to MasterCard (MA), regional networks and the aforementioned digital platforms.
Visa will remain a solid company, but I think its valuation needs to be ratcheted down to the 20x-22x eps. Based on the 2017 earnings estimate of $2.90 per share, it gives Visa a fair value of around $64, or a 14% decline from current price.
I’m using the purchase of the June 75 put for $4 per contract as a limit risk way to get some bearish exposure.