Written by David Houston and Nick Gomez
I have been watching Visa (NYSE: V) and MasterCard (NYSE: MSc) For months on weak forecasts, while seeing the company’s gap and gap when forecasting its annual results. To be sure, despite a successful recovery from the bottoms of the pandemic, the market was not affected enough to keep stocks high and prices fell in both companies. I intend to explain why this is a good place to start a long position, and I will do so based on Mary Buffett and David Clark’s book: Warren Buffett and Financial Statement Interpretation.
What better way to study a high-margin, bombshell balance sheet company like Visa than to use the metrics the Oracle of Omaha uses to rate its favorite broad-ditch businesses.
Visa Inc needs little introduction as a global payment technology company that operates across the globe. I’ve had a Visa or debit card in my pocket for twenty-five years – give or take – and many of us will be familiar with digital payment solutions that connect consumers, merchants, financial institutions, businesses, and even government entities. Primary brands include the Visa, Visa Electron, Interlink, VPay and Plus brands. In fact, in 2020 it handled 40% of all payment transactions globally.
There is more to this story than its omnipresent brand – although I intend to explain why Visa is a market leader that still has strong growth potential.
Balance sheet and income statement
Visa is essentially a growth story linked to the explosion of electronic and digital payments, which surpassed cash payments just a few years ago. There is a lot of gas left in the tank for this topic which is why Visa maintains a broad moat rating among analysts. Visa actually has a fee kiosk business model where you earn fees when people pay using credit, debit, or through their mobile phones.
To dig deeper into the basics, let’s follow Mary Buffett’s advice on how to evaluate Visa’s balance sheet using the metrics Warren Buffett uses to determine whether or not a company has a wide moat. This can get very complex and subtle, so for space saving purposes, here’s a final assessment of Visa’s income statement and balance sheet using the principles in the book in traffic light format:
Source: Analysis produced by David Houston
There is a lot of green for a reason – Visa is a solid cash-generator with a broad moat with a gross margin of 76% and a track record of turning that revenue into net income and realized profit that is growing exponentially over time. Let’s go over some of the main actions:
Visa keeps costs low with 13.8% SG&A costs, Buffett says anything under 30% is great
Depreciation expense as a percentage of profit is 4.4%, which is great
Visa has more than 20% of net income/total revenue under GAAP, and achieved a staggering 51% in the fourth quarter while beating previous estimates. That’s too high!
The stock price has gone up in 7 of the past 10 years and a steady trend for decades
Moving on to long-term debt, you could pay that off in about two years of profit. surprising.
Retained earnings growth is up for 5 out of the last 5 years, we expect 5-10% growth here for strong business with wide moat
Its ROE is 23.6% and paired with its strong earnings track record indicates that this is undisputedly a broad-based business.
The positives are evident here from the balance sheet and income statement. Looking at the most recent fourth-quarter results for 2021, they’ve been generally positive. Visa outperformed revenue with $6.6 billion reported (+29% y/y) and core metrics of payments volume, cross-border volume, and processed transactions rose against fiscal third quarter levels and beat 2019 results.
Expectations expressed during the last quarterly conference call were lower than expectations and during the earnings call directing the “High Teens” earnings growth and “Mid-range Teens” earnings growth were set, which were lower than analysts’ expectations.
Personally, this is the kind of reaction I like. A world-class company with solid earnings, it sells due to perceptions of slower growth in the following quarters; This feels more like a speed bump than anything structural. The chart below shows that a consumer has plenty of room on their credit card before they return to their pre-pandemic debt levels. They are not likely to stop using their card anytime soon.
Source: The Traders, stockcharts.com
Of course, we need to be aware and aware that growth can slow. I don’t see this as a major headwind, and certainly not worth the 10% discount on the entire company’s value. Analysts seem to agree if you look at their predictions:
Source: CIBC Capital Markets
Visa Headwinds and Risks
There are a few headwinds that need to be addressed briefly. The first is from a technical analysis perspective: There is a floor below participating in Visa from these levels. At Away From the Herd, we advised our subscribers to exercise caution if Visa maintains negative momentum below $208 per share. It clearly formed a base at $208 going back to March 2021 and retraced from that level on November 3rd. Provided we can stay above that level and especially above the $205 level, there is plenty of room to cover to bring us back to the $250 that traded in July of this year.
Source: Trade, stockcharts.com
The second headwind is the Department of Justice investigation that has opened into Visa’s relationship with other fintech operators such as Square and PayPal. The crux of the issue is whether Visa has used anticompetitive practices in the debit card market by limiting the ability of merchants to route transactions through other card networks even if they are less expensive.
Comprehensive assessment of the visa
Visa has a fortified balance sheet, is a cash-generating company whose share price was recently taken down due to concerns about future revenue guidance in the coming year. We believe this reaction is overrated and that Visa and Mastercard are worth considering as potential investments.
The Department of Justice’s investigation into Visa needs to be monitored as does the recent weakness in the payments space. Visa appears to have formed a base of just over $200 and presents a good risk reward scenario from here.
Master Card Credit Card
I sometimes see Mastercard referred to as a smaller, leaner version of Visa. Although it’s smaller – with a market capitalization of $357 billion – it’s not a small yacht or fishing sail by comparison. If we take a look at the volume of purchase volume for global payments in 2019, we can see the difference:
A lot of what we said about Visa can be said again for Mastercard. It is also a technology company that facilitates payments and processing, including authorization, clearing, settlement, and related financial services products. It has also been a huge beneficiary of the ongoing shift to digital and electronic payments as the company processed nearly $5 trillion in purchase transactions during 2020. Together, Visa and Mastercard dominate the global payment space with a combined market share of 45% as of 2019 given that UnionPay dominates payments with 99.5% of its business in China, I tend to agree with analysts who say that Visa and Mastercard have virtually a double monopoly in global payments (with the exception of China).
MasterCard Fundamentals and Analyst Forecasts
Mastercard reported third-quarter earnings of $5 billion and net income of $2.4 billion for 2021, which represents a 30% year-over-year increase in GAAP revenue and a 59% increase in net income. To put how well this performs in perspective, let’s take a look at the comparison. Tesla reported $13.7 billion in revenue in the third quarter with just $1.6 billion in net income. Mastercard on these actions has a 48% profit margin versus Tesla’s 11.7% profit margin. Tesla is aiming for a medium-term profit margin of 14.6% while Mastercard is seeking to defend and maintain the 40% profit margin it has achieved since 2009.
Using the above measures for evaluating Mastercard’s balance sheet and income statements, we get a similar result for Visa. So instead of going into the same level of detail, let’s extract several highlights:
Mastercard has increased its revenue every year since 2005 except for the Covid-19 pandemic, where it has fallen by three quarters
Current ratio 1.33
Return on equity >50% since 2009 and currently 123% in Q4
Return on Equity of 35% (Net Income / Equity)
PE 47.21 which is located on the high side
This is a good example of a great job that still, indeed, lacks the 20% safety margin. But what’s interesting is that the recent weakness in the stock price has wiped out much of this premium:
Source: CIBC Capital Markets
It would also not be surprising if we jump straight to the fact that the analyst consensus for Mastercard is very similar to Visa – there are a lot of upsides and the risks to the downside are fairly minimal:
Source: CIBC Capital Markets
What we expect to see over the coming quarters is for Mastercard to maintain impressive profitability metrics and continue to grow revenue over 10%. TTM revenue growth of 14% indicates that we are on the right track and last quarter performance indicates that we are looking to deliver consistent earnings and earnings growth over the next two years.
MasterCard Technical Analysis
Recently, since we tipped these two companies, Mastercard outperformed Visa. We noticed an interesting trend of higher standard deviation when comparing the stock price of the two companies. Note that spikes in standard deviation tend to mark the beginning of progressions in Both Companies (green sectors below):
Source: The Traders, stockcharts.com
Overall, the technical picture is favorable for the $330+ Mastercard and we will be watching closely over the coming weeks and months on our own service.
The benefits of understanding what the company does and how it operates, as well as where it stands in relation to the competition, means that you can continually invest in companies that can “survive” for the long term. Ultimately, that also translates to being able to understand whether a 10% decline in the company is fatal, due to the underlying issues the company is facing, or whether it is an overreaction to bad news.
Looking at the fundamental and technical picture of Visa and Mastercard, we tend to believe that these factors affecting the short-term weakness in the stock price are temporary and provide a buying opportunity for investors to consider.
However, let’s pay close attention to the risks. Visa has conducted investigations from the Department of Justice in the past and both Visa and Mastercard have to deal with a regulatory environment that could lead to heavy fines if they are found to be using their monopoly power to unfairly limit competition. Likewise, these companies are trading at a very high valuation and therefore they need to continue to increase revenue and profits to be worthy of this valuation.