Swipe Profits With This Industry Giant

Joseph is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Over the last several years, the world has begun its switch from paper money to plastic cards. This trend has fueled incredible growth for credit card companies, and made Visa (NYSE: V) a goldmine for investors. After pulling back about 11.5% in less than a month, Visa could be a great value play at this level. 

The company and its quarter

Visa is the world's largest retail electronic payments company. It allows consumers, businesses, banks, and governments in more than 200 countries to connect and collect payments without using cash or checks.

Visa released its third-quarter report on July 24, and it was nothing short of spectacular:

  • Earnings per share of $1.88 vs. estimates of $1.80
  • Revenue of $3.0 billion vs. estimates of $2.9 billion
  • Net income of $1.2 billion
  • Authorized $1.5 billion share repurchase program
These results were also impressive compared to the third quarter of 2012. Visa's Q3 2013 earnings per share rose 20%, revenue rose 17%, and net income rose 16% year-over-year. The most important statistic to note is the 13% growth of payment volume to $1.1 trillion. This boosted service revenue growth, which pushed earnings higher than expected. It's safe to say that Visa delivered in the third quarter.

Earnings outlook

Management is confident that it'll meet fiscal 2013 guidance, and that its earnings momentum will carry over into 2014. The chief executive officer noted that accelerated opportunities within mobile and e-commerce, along with increased payment volume internationally, would primarily drive its growth going forward.

Here are the earnings from 2011 and 2012, with the consensus analyst estimates for 2013 through 2015 provided by TD Ameritrade:

<img alt="" src="http://g.foolcdn.com/editorial/images/65947/chartgo_large.png" />

Analysts predict 22.4% EPS growth in 2013, with 17.3% growth for each of the two following years.

Where it could go from here

The chart above clearly shows that Visa's earnings are consistently moving in the right direction. Today, Visa trades at 21.1 times earnings; if it were to trade at this same multiple in 2015, its shares would exceed $220. This represents a phenomenal potential return for investors, and makes the case that Visa is a value play at its current level. 

Free cash flow at its best

In its third-quarter report, Visa affirmed that it expects free cash flow of $6 billion in 2013 and another $5 billion in 2014. With cash and cash equivalents of $6.5 billion and consistent free cash flow projections, Visa is in a great position to continue to benefit its shareholders by paying dividends and buying back shares.

Visa currently pays a quarterly dividend of $0.33 per share, giving it a yield of about 0.76%. That yield wouldn't catch most investors' eyes, but remember that Visa has raised this dividend for five consective years. I expect this trend to continue with a raise in the fourth quarter due to the rising free cash flow.

In the third quarter, Visa repurchased 6 million shares for roughly $981 million. On the heels of this bullish move, management announced another $1.5 billion in repurchases by July of 2014. If the stock continues to trade at these low levels, I would expect the current repurchase to be increased to more than $2 billion. 

The competition

MasterCard (NYSE: MA) and American Express (NYSE: AXP) are Visa's two largest competitors in the credit card industry. Let's break down the three companies' valuations:

<table> <thead> <tr><th> <p><strong>Company</strong></p> </th><th> <p><strong>Visa</strong></p> </th><th> <p><strong>MasterCard</strong></p> </th><th> <p><strong>American Express</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>Market Cap</p> </td> <td> <p>$111.99 billion</p> </td> <td> <p>$74.58 billion</p> </td> <td> <p>$81.74 billion</p> </td> </tr> <tr> <td> <p>P/E</p> </td> <td> <p>21.1</p> </td> <td> <p>25.65</p> </td> <td> <p>18.41</p> </td> </tr> <tr> <td> <p>Forward P/E</p> </td> <td> <p>19.52</p> </td> <td> <p>20.23</p> </td> <td> <p>14.05</p> </td> </tr> <tr> <td> <p>Dividend Yield</p> </td> <td> <p>0.76%</p> </td> <td> <p>0.39%</p> </td> <td> <p>1.23%</p> </td> </tr> <tr> <td> <p>YTD Return</p> </td> <td> <p>11.9%</p> </td> <td> <p>21.26%</p> </td> <td> <p>27.46%</p> </td> </tr> <tr> <td> <p>% below 52-week high</p> </td> <td> <p>11.47%</p> </td> <td> <p>5.89%</p> </td> <td> <p>4.67%</p> </td> </tr> </tbody> </table>

Source: Yahoo! Finance.

Visa, MasterCard, and American Express are all extremely strong companies, as this comparison shows. MasterCard trades slightly higher than its 5-year average price-to-earnings of 24.8 and American Express has exceeded its average of 15.8 much more. This information gives the impression that the underlying stocks are ready for a pullback in order to make a healthy run higher.

With that said, I prefer Visa due to its underperformance year to date and its pullback of over 10% from its 52-week high, all while being the largest player in the industry. I'd only consider this a bad situation if earnings flatlined or the smaller companies were taking share -- neither of which seems likely, given Visa's strength going forward. 

The Foolish bottom line

Visa is a screaming buy at its current level. It has the potential to outperform its industry and the overall market for the remainder of 2013. MasterCard and American Express are other ways to play the growth of the industry, but I would wait for a pullback in those names before considering an investment. Take a look and see if the largest electronic payments company in the world would fit in your portfolio. I have initiated a long position in Visa and will add to it on any weakness. 

Joseph Solitro is long Visa. The Motley Fool recommends MasterCard and Visa. The Motley Fool owns shares of MasterCard and Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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