Visa Inc (V)

[esmagnus]

Visa: Not everywhere you want to be

The credit card issuer has proven impervious to slower consumer spending so far. But with Visa's stock up nearly 50% since its IPO, some think a pullback may be in the cards.
By David Ellis, CNNMoney.com staff writer
May 21, 2008: 11:10 AM EDT

NEW YORK (CNNMoney.com) -- While the rest of the financial services industry has zigged, Visa has zagged.

Just two months after Visa's stock hit the market in the largest initial public offering on record, shares of the credit card processor have soared 46%.

Even with the turmoil in the broader financial sector, the San Francisco-based company has proven that it can deliver. When Visa reported quarterly results for the first time as a public company last month, it booked a profit of $314 million, or 52 cents a share, handily beating Wall Street estimates of 44 cents a share.

The U.S. economy may be at a near standstill and consumers are increasingly getting squeezed by rising food and gas prices. But the consensus among analysts is that Visa should continue to do well.

"If you are an investor, it is one of the more resilient names you can hold in this environment," said Moshe Katri, managing director at Cowen and Company.

At its heart, Visa is a toll booth operator, levying fees on banks and credit card issuers who use their network.

Visa and top rival MasterCard (MA), whose shares have climbed 29% year-to-date, have virtually cornered this segment of the credit card industry.

What has largely kept these two firms from feeling the effects of the credit crunch this year is that they don't lend directly to consumers. Peers Discover (DFS) and American Express (AXP, Fortune 500) face the threat of getting squeezed if more and more consumers begin defaulting on their credit card payments.

Large financial institutions with big credit card loan portfolios like Citigroup (C, Fortune 500) and Bank of America (BAC, Fortune 500) have already started to prepare for such a scenario by ramping up their loan loss reserves in recent months.
Consumers still charging up a storm

Instead, the real risk to the business model for Visa and Mastercard is a decline in consumer spending via credit or debit cards.

So far, this seems to be not a major concern however as consumers around the world increasingly rely on electronic forms of payment instead of more traditional means like cash or checks.

Credit and debit card transactions worldwide combined are expected to grow 15% annually through 2012, according to Nilson Report, a trade publication that tracks the payment industry.

What's more, there are few signs that consumers are abandoning their cards in the current environment.

Those Americans who can't borrow from the equity built up in their homes are increasingly turning to their credit cards to make ends meet. Even those consumers who are trying to cope with the tough economic climate by curbing their spending are still relying on their debit cards to pay for food and gasoline.

That bodes particularly well for Visa, which generates about half of its revenue from debit card transactions. Only about a quarter of MasterCard's revenue is generated by debit cards.

"Volume should be relatively unaffected by a broad economic downturn," wrote Andrew Jeffrey, an analyst at SunTrust Robinson Humphrey, in a research note published late last month. "In fact, rising food and energy prices may actually translate into modest debit volume growth."

Overseas growth has also been phenomenal for Visa and MasterCard recently. Both companies said that card usage grew at a double digit pace in Latin America and parts of Asia when they reported results last month.

But maybe the biggest driver of growth for the pair has been cross-border use, fees generated when travelers use their credit cards overseas.

During the first three months of this year, those transactions made up more than a fifth of net revenue for both Visa and MasterCard. They are also very high-margin businesses.

"That part of the business is extremely profitable for both networks," said Cowen's Katri.
More money, more problems

With that in mind, a global economic slowdown or even higher commodity prices could hurt both companies if it leads to a pullback in travel. As such, Katri said that a slowdown in airline traffic, and not overall consumer spending, is the biggest concern for Visa

There are other risks facing Visa and Mastercard as well. Both firms are saddled with a number of antitrust lawsuits from retailers over their fee structure. (Visa and Mastercard set the so-called "interchange" fees that merchants pay to banks to process card transactions.)

They also face the likelihood of fewer bank customers if there is more consolidation in the financial services industry.

Still, the outlook for both Visa and MasterCard in fact appears quite promising.

Wall Street expects Visa to report earnings of $2.03 a share on revenue of $6.14 billion in fiscal 2008, which ends in September. Analysts are forecasting earnings growth of over 20% a year during the next five years. They expect Mastercard's profits to increase 19% annually during the same period.

But neither stock is a bargain.

"There's a lot of exuberance and optimism about the ability of these businesses to outperform," said Ben Stretch, analyst at Macquarie Capital in New York, who has a "neutral" rating on both stocks. "My overall feeling at the moment is that they are overvalued."

To that end, shares of Mastercard trade at 26 times 2009 earnings estimates while Visa trades at roughly 33 times analysts' earnings forecasts for its next fiscal year.

And even though both Visa and MasterCard have have ample room to cut costs in order to keep earnings growth on track in case revenue starts to slow, their shares still look pricey.

So while analysts are in agreement that Visa and MasterCard stock are worth holding onto, this might not be the right time to snap up more shares of either company. Investors would probably be better off waiting for them to take a breather first.