It’s hard to find anything wrong with Visa’s (V) business model. The company offers a secure, payment network that is accepted virtually everywhere in the United States. The firm makes money every time a Visa user swipes his or her debit or credit card. The company does not take on credit risk – or the risk that users will pay outstanding balances on the credit cards. This attribute makes its business model much more attractive (less risky) than that of a Discover (DFS), for example.
Visa benefits from two fantastic competitive advantages: a network effect and costly initial investment. The network effect is incredibly strong. As of its last update, the firm has more than 2 billion cards outstanding accepted by retailers across the world. The number is roughly double the number of MasterCard (MA) cardholders and over 20 times the amount of American Express (AXP) cards outstanding. This network effect took years, as well as billions of dollars to create–something that won’t easily be replicated by any new entrant.
Visa generates strong operating margins in the 60% range, leading to large levels of free cash flow generation. The firm is also one of the most shareholder-friendly companies in our coverage, buying back stock with surplus cash flow. All of these positive characteristics were on display when the company reported fiscal fourth-quarter earnings October 29.
In the report, Visa reported GAAP net operating revenue of $3.2 billion, an increase of 10% on a constant dollar basis over the prior year. Payments volume growth advanced 12% over the year-ago quarter, while total processed transactions increased by 9%. The company recorded adjusted quarterly net income of $1.4 billion or $2.18 per diluted common share, an increase of 14% and 17% over last year’s quarter, respectively. As management stated, the firm’s “enviable competitive position, strong business model, and great talent helped (it) deliver…in the face of continued tepid economic growth and a strengthening dollar.”
Looking ahead to fiscal 2015 (ends September next year), Visa expects to post annual net revenue growth in the low double digits, with its annualized operating margin in the mid-60% range. Earnings per share is expected to advance at a rate in the mid-teens, while free cash flow for the year is anticipated to be greater than $6 billion. Visa continues its pristine track record of shareholder-friendliness, recently upping its dividend and authorizing a new $5 billion share repurchase program. Of note, MasterCard’s third-quarter results were also solid as we continue to move toward a society less dependent on cash for transactions.
Though we like MasterCard as well, we include Visa as a core holding in the Best Ideas portfolio. Neither boasts an abnormally high dividend yield at the moment, and we’ve opted for Visa on the basis of its larger scale and network relative to MasterCard.