This article first appeared in the February edition of the Best Ideas Newsletter, February 15.
Visa (V), a holding in the Best Ideas portfolio, is one of our favorite companies. The credit card giant benefits from a fantastic network effect, a dynamic that occurs as a result of more users swiping its cards driving more merchants to adopt the company’s network, which drives more users and so on. Visa’s operating margin is among the best in our coverage universe, and the company’s recently-reported fiscal first-quarter results showcase such strength.
In the report, Visa reported currency-neutral operating revenue growth of 9%, which it levered into an 11% increase in net income and a 15% jump in earnings per share, to $2.53 per share. Both the top and bottom line were better than expectations. Solid expansion in service revenues, data processing revenue, and international revenue offset headwinds from a strengthening dollar. Visa’s operating margin was perhaps most impressive, expanding more than 30 basis on a year-over-year basis, to 66%. This is a phenomenal level of profitability.
Visa announced it will perform a four-for-one split with the spilt adjusted price beginning on March 19. After the stock split the relative ownership percentages will remain the same for class A, B, and C stockholders. Visa also declared a $0.48 quarterly dividend. Annualized that is a $1.92 per share. Visa’s Valuentum Dividend Cushion ratio is 8. This means that it is able to cover the future dividend payments 8 times with net cash on the balance sheet and future free cash flow.
The company’s outlook for fiscal year 2015 (ending in September) looks solid as well. The constant dollar revenue growth is expected to be in the low double digits for the year, despite currency headwinds. The annual operating margin is expected to be in the mid-60s, which is solid by any measure. Perhaps most encouraging is that annual free cash flow is expected to be over $6 billion, more than 40% of expected revenue for the year. The company’s ability to convert a dollar of revenue into a dollar of free cash flow is impressive.
All-in, we were very encouraged by Visa’s performance, especially its pace of earnings expansion and solid generation of free cash flow. The company’s arbitrary stock split won’t generate any value, but we think it may be a sign of better times ahead. Though the firm’s dividend isn’t a head-turner, it certainly is healthy, and the credit card giant’s Dividend Cushion ratio is about as good as it gets for the size of its yield (0.7%). Our fair value estimate of Visa is $290 per share, north of the $260 price tag at which shares currently can be scooped up.