Visa (V) is a payments technology company that holds a very dominant position in the industry. We are neutral on the stock.
Competitive Advantage
Visa’s main competitive advantage is that it has a dominant position in the payment market. It is in a duopoly, with Mastercard (MA) being its main competitor.
Since both brands are highly recognized and trusted, it makes it more difficult for competitors to disrupt their dominance. Trust is especially important when it comes to handling financial transactions.
There are also a couple of ways to quantify a company’s competitive advantage using only its income statement. The first method involves calculating the earnings power value (EPV).
Earnings power value is measured as adjusted EBIT after tax, divided by the weighted average cost of capital, and reproduction value can be measured using total asset value. If earnings power value is higher than reproduction value, then a company is considered to have a competitive advantage.
The calculation is as follows:
EPV = EPV adjusted earnings / WACC
$172 billion = $12.9 billion / 0.075
Since Visa has a total asset value of $82.9 billion, we can say that it does have a competitive advantage. In other words, assuming no growth for Visa, it would require $82.9 billion of assets to generate $172 billion in value over time.
The second method is by looking at a company’s gross margins because they represent the premium that consumers are willing to pay over the cost of a product or service. An expanding gross margin indicates that a sustainable competitive advantage is present.
If an existing company has no edge, then new entrants would gradually take away market share, leading to decreasing gross margins as pricing wars ensue to remain competitive.
Although the image below appears to be volatile, we can see that gross margins have essentially remained flat over the past several years between 96-97%. As a result, Visa’s gross margins indicate that a competitive advantage is present in this regard as well.
Risks
As dominant as Visa is, it still has some risks investors need to consider. To begin with, there has been some fear recently that companies such as Amazon can exert enough pressure on Visa to lower its fees on transactions.
In addition, there are other risks associated with the company. According to Tipranks’ Risk Analysis, Visa disclosed 22 risks in its most recent earnings report. The highest amount of risk came from the Legal & Regulatory category.
The total number of risks has remained relatively flat over time, as shown in the picture below.
Valuation
To value Visa, we will use the H-Model, which is similar to a three-stage DCF model. The H-Model assumes that growth will decelerate linearly over a specified period of time. We believe this is a reasonable assumption as companies gradually slow down as they mature. The formula is as follows:
Stock Value = (CF(1+tg))/(r-tg) + (CFH(hg-tg))/(r-tg)
Where:
CF = cash flow per share
tg = terminal growth rate
hg = high growth rate
r = discount rate
H = half-life of the forecast period
For Visa, we used the following assumptions:
CF = $6.83 per share
tg = 2.073%
hg = 11.7% (based on analysts’ estimates)
r = 6.014%
H = 5 years (we are assuming it will take 10 years to reach terminal growth)
As a result, we estimate that the fair value of Visa is approximately $260.32 under current market conditions.
Wall Street’s Take
Turning to Wall Street, Visa has a Strong Buy consensus rating, based on 12 Buys, two Holds, and zero Sells assigned in the past three months. The average Visa price target of $266.57 implies 24% upside potential.
Final Thoughts
Visa is a high-quality company that is undervalued under current market conditions. Nonetheless, we remain neutral on the stock because it is on a downtrend.
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