The credit card processors, Visa and MasterCard, have been my core holdings of mine for years (more so MasterCard). I am a big fan of their business models. Can they also be good dividend growth stocks?
Visa is one of the major credit card networks in the world, along with MasterCard, Amex and Discover. Highly likely that somewhere in your wallet, you may have your own branded visa card that has been issued to you by your bank. Visa is an almost $100B business, with $10.5B revenue and 80% gross margin.
How does Visa make money? Each time a credit card or debit card transaction is processed on the Visa network, Visa charges the merchants who put through that transaction an assessment fee. This is basically a small percentage of the total transaction value.
On average, Visa keeps something like 0.2% of the average transaction value for a credit card transation. While the merchant is paying more per transaction (something in the order of 2%), Visa has to pass on some of this to the bank who issues the visa card and the bank that the merchant banks with.
It’s a fairly complex ecosystem, but the important thing to remember is that VIsa take a small piece of every transaction that takes place on its network. Unlike American express, Visa doesn’t do any consumer lending.
What this means is that it doesn’t take any credit risk, this all sits with the bank that issues the card. So that person defaulting on their credit card payment doesn’t really affect Visa at all, as Visa makes money each time from processing the transaction and not on the lending.
Credit card networks have huge moats. It’s not an easy task to set up a network, what with needing to have banks issue the cards, consumers use the cards, and merchants to accept the cards. The network effects are significant and not easy to replicate. It’s the reason that credit cards networks are one of my favorite businesses along with the Chicago Mercantile Exchange.
Where is the growth?
Increasing spend – we are moving more and more to a cashless society. While penetration of credit cards is fairly high in western economies, the amount of spend thats being put on credit cards is increasing. Cheques and cash are decreasing in use . Check usage globally has decline from 22% in 2005 to 16% in 2009.
Increasing acceptance – Credit cards are being accepted by merchants who previously hadn’t accepted them thanks to lower costs of Point of Sale terminals. The emergence of mobile Point of Sale terminals such as Square and Paypal have led to the credit card acceptance by greater number of merchants who previously hadn’t accepted them before, all of which will contribute additional purchase for Visa
International – Credit card penetration amongst some of the rapidly growing BRIC countries has been rapidly increasing. Russia and China have seen increases in credit card penetration to 24% and 65% respectively from single digits in early 2000′s. As disposable income increases, the average spend per user will also increase, contributing to additional credit card volume.
What do the numbers say?
Visa doesn’t have publicly available information for a 10 year period so this analysis will be done on a 5 year view
Visa compound revenue growth over the 5 year period (2008-2012) has been a very respectable 14% p.a .
5 year operating cash flow growth
Visa operating cashflow over the year period has also been an eye popping 77% p,a in the 5 years from 2008-20012. I believe that the initial couple of years in the measurement period was probably artificially depressed with extraordinary charges. Cashflow growth from 2011- 2012 was an impressive 32%
Dividend Growth Rates
Visa has had a dividend in place since 2009 and this dividend has increased by 28% p.a over the 2009-2012 period. A review of its payout ratio suggests Visa has plenty of scope to increase its dividend further.
Visa has maintained a payout ratio that has been consistent under 20%. Even with the significant increase in its dividend in 2012, I estimate Visa’s payout ratio to have still been no more than 25% (some special charges artificially depressed Visa’s income in 2012).
I believe Visa has plenty of scope to raise its dividend quite substantially, at least doubling it from where it is today. This is a business that doesn’t require a lot of capital spending (a review of capital spending for the last couple of years reveals a mere $350M in capex for Visa).
Whether it will do so is a another question, but once its overseas expansion program is further advanced then I think it will significantly ramp its dividend within 2-3 years, potentially putting it on a yield of about 2%.
Visa is in my view the poster child of a wide moat business. It currently generates strong revenue growth, and tremendous free cash flow growth. As a dividend growth stock, it does leave a little to be desired. With a very small current yield, it will likely take extraordinary growth in dividends and a long term view for dividend income to be comparable to other higher income yielders that offer 3.5% plus.
Having said that, I sometimes look to hold businesses just because they are great businesses, irrespective of the fact that the initial dividend may be small. I believe that Visa can and will increase its dividend and provide strong dividend growth over a lengthy period of time. Its a stock that I’m happy to hold onto indefinitely, pending periodic reviews of business performance.
Visa is currently trading at premium in my view at $160/shr (I was able to pick it up in early 2012 at just over $100). A decline in price with a bump in the yield may present a more compelling opportunity to enter the stock.