Profit ratio

An undervalued visa offers a safe

Stocks that offer low dividend yields tend to compensate for lower income levels with high growth rates. This makes these stocks more attractive to those looking for a fast-growing dividend rather than just income.

A good example of this is Visa Inc. (V, Financial), which has increased its dividend aggressively since its IPO. Additionally, stocks are trading at a discount to both their historical average multiple and their intrinsic value.

Let’s take a closer look at the business to see why I think Visa’s safe dividend can deliver value today.

Company History and Earnings History

Visa had its IPO in early 2008, raising nearly $18 billion in what is still the largest IPO in US history. The $444 billion company generates $24 billion in annual revenue.

Although it has many tailwinds, the size of Visa’s payment network is its main competitive advantage. The company operates the world’s largest retail electronic payment network. Visa’s network can handle nearly 65,000 transactions per second, making it a very reliable network for financial transactions.

Another factor working in the company’s favor is that the transition from cash to credit card payments continues apace. Around $6 trillion in electronic payments were made in 2021, an increase of 40% over the past two years.

This is partly due to the effects of Covid-19, as consumers have been forced to buy more goods and services online, but this transition has been happening for some time. The pandemic has just accelerated this trend. The rise of e-commerce can be seen in almost every industry as this method of shopping is now used by a large number of people. Visa, with its industry-leading network, is in an advantageous position to capitalize on the continued shift from cash to card payments.

With more than 3.8 billion cards used in the last quarter, Visa has an incredibly large customer base. This makes the card a favorite with merchants as they seek to attract as wide a group of customers as possible.

The aforementioned Covid-19 pandemic weighed on the company’s results, particularly in Europe where cross-border transactions are so important. Company-wide cross-border volumes fell 40% per quarter during the height of the pandemic. The good news is that cross-border volume growth has largely returned in recent quarters, showing a rapid rebound in business activity.

Revenues over the past decade have a compound annual growth rate of over 9.8% over the past decade. Earnings per share have increased nearly 16% over the past 10 years. A reduction of nearly 900 million shares during the period helped results, but net income has grown at a compound annual growth rate of 14.5% since 2012. Net profit margin improved by 40, 3% in 2012 to 51.1% last year, a gain of 1,080 basis points for the period 2012-2021.

Visa is the rare company that has seen incredible growth rates for a long time but still looks likely to show high growth in the future. Analysts expect the company to generate earnings per share of $7.07 in 2022 and $8.37 in 2023, implying growth of 19.6% for this fiscal year and 18.4% for the next exercise.

Visa shares return just 0.7%, half the average return of the S&P 500 index.

History of recessionary performance and dividend growth

Visa entered the public markets in the midst of the Great Recession, but showed extremely good results early on as a publicly traded entity.

Below are the company’s adjusted earnings per share totals during and after the last recession:

  • 2008 adjusted earnings per share: 56 cents
  • 2009 adjusted earnings per share: 81 cents (up 44.6%)
  • 2010 adjusted earnings per share: 98 cents (21% increase)
  • Adjusted earnings per share 2011: $1.25 (up 27.6%)
  • Adjusted earnings per share 2012: $1.55 (24% increase)

Visa saw substantial business improvement in the last year of the Great Recession, and the company has produced excellent numbers almost every year since. Only the 2020 financial year, which covered the majority of the calendar year, saw a decline. This period saw only a 5.3% drop in earnings per share, mainly due to the pandemic.

The next recession could present headwinds for the company, but Visa’s leadership position in an industry that continues to grow could prevent drastic declines for the company.

That should mean Visa can continue to raise its dividend, which the company has been doing for 14 years. The past decade has seen a CAGR of 22.2% as the company has aggressively increased its dividend. Few companies, if any, can sustain such a growth rate as the size of the dividend increases.

That said, Visa’s most recent increases remain aggressive. The company increased its dividend by 17.2% at the end of October last year, which is close to the five-year compound annual growth rate of 18%.

Payout Ratios and the Impact of Debt on Future Dividend Growth

Along with strong dividend growth rates, Visa’s payout ratios are very low.

Visa paid out $1.34 in dividends per share in the past fiscal year, while generating earnings per share of $5.91. This equates to a payout ratio of 23%. Shareholders are expected to see dividends totaling $1.50 for 2022, resulting in an expected payout ratio of 21% according to analysts’ estimates for the year. Both payout ratios are very close to the 10-year average payout ratio of 20%.

Free cash flow paints a similar picture. Visa distributed dividends of $2.8 billion in the past fiscal year. Free cash flow totaled $14.5 billion, which translates to a payout ratio of 19%. The previous three years had an average free cash flow payout ratio of 20%.

Visa’s earnings and free cash flow ratios are almost identical to the respective averages. The company has more than enough leeway to continue increasing its dividend even in the face of extreme headwinds. Even in the quarters where Covid-19 had the most profound impact on the business, Visa still increased its dividend by almost 10%.

A high-growth business coupled with very low payout ratios means investors will likely continue to see double-digit dividend increases for the foreseeable future.

Debt, while important to consider, seems unlikely to have an impact on the company’s dividend growth.

Visa had interest expense of $513 million in 2021. Total debt was nearly $21 billion at year-end, giving the company a weighted average interest rate of 2 .4%.

The image below shows where Visa’s weighted average interest rate would need to reach before free cash flow is no longer sufficient to support dividend payments.

Source: Author’s calculations.

As you can see, Visa’s weighted average interest rate is expected to exceed 58.3% before dividends are not covered by the company’s free cash flow.

Given the current low weighted average interest rate and the amount of free cash flow generated by Visa, debt obligations are unlikely to impact the company’s ability to continue to pay and increase its dividend.

Evaluation

Shares of Visa are currently trading at 29.8 times forward earnings. The stock has traded with an average price-to-earnings ratio of 27.5 over the past decade. The five-year average multiple is closer to 32 times earnings, so the stock is slightly overvalued over the long term, but undervalued using the medium-term average.

The GF value chart indicates that Visa is undervalued relative to its intrinsic value.

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With a stock price of $211 and a GF value of $245.11, Visa has a GF price-to-value ratio of 0.86. Achieving the GF value would result in a 16.1% gain in stock price.

Final Thoughts

Visa has been a very successful company since entering the public market. Almost all metrics grew at a double-digit pace. Many of these measures show no signs of slowing down.

The strong business model has supported impressive levels of dividend growth for over a decade. The company is positioned to continue to increase its dividend at a very high pace due to numerous tailwinds. The payout ratios are also very low.

Shares of Visa are trading at a decent discount to the intrinsic value of the stock, giving investors the opportunity to buy a stock that has a safe yield, the likelihood of double-digit dividend growth and potential total returns in the mid-double digit range.