Give More Credit to This Credit Card Company!

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The economic recovery in the United States and consistent growth in emerging economies like China have resulted in higher consumer spending across the globe. This has proved to be a blessing for industries like retail, housing and automobile.

Apart from these, one other industry that has benefited from greater consumer spending is the credit card business. One of the leading companies in global payments technology, Visa (NYSE: V) reported robust results for Q3, 2013 on the back of better spending and a surge in credit transactions.

Let us now look at some important metrics.

A healthy quarter

Visa’s net revenue grew a massive 17% in the third quarter, which also includes considerable savings on client incentives. The growth in income was essentially brought about by a broad based increase in payment volume. For the June quarter, global payment volume growth in constant dollar terms was 18%, attributable to consistent growth across all regions in the U.S. The company incurred less on client incentives this quarter, which also enhanced overall profits. The amount spent on client incentives decreased by 200 basis points as a percentage of gross revenues in Q3, 2013 as compared to Q2, 2013.

Agreement with JPMorgan

Visa’s service revenue was down sequentially from Q2, 2013 but grew 7% on a year-over-year (YoY) basis. The primary reason behind this is the 10-year deal that was signed between Visa and JPMorgan in February. As a result of the deal, Visa earned fewer gross fees in the quarter. However, it was offset by a reduction in client incentives, also a consequence of the deal. Additionally, JPMorgan will also transfer extra credit and debit card volume to Visa, which will supplement its revenue in the future.

Visa has some really strong numbers

Now, let’s talk a bit about Visa’s financials. The first thing that catches my attention is the fact that it is a zero debt company, which is quite a favorable sign. Besides this, its current ratio works out to nearly 1.8, indicating reasonable liquidity to meet long term or short term payment problems. While the operating and marketing expenses increased in the quarter, stronger than expected revenue helped the company achieve a comfortable operating margin of 61%. It is definitely good to see that the company has sustained a healthy margin over time in spite of investing considerably in growth opportunities and brand promotion.

There are some things money can’t buy, for everything else there is...

If Visa is one huge pillar in the payments technology industry, Mastercard (NYSE: MA) is the other. Its stock has gained approximately 37% over the last 12 months because of consistent earnings and sustainable growth record. The company is due to announce its quarterly results on July 31 and is expected to perform well in light of the improving economy and with more customers shifting to credit and online payments. Even though I completely love the way Mastercard has created value for its shareholders, I am not highly positive about the company’s current valuation. It has a PBV ratio that is twice of Visa’s, while its earnings growth has been slightly lower than Visa in the recent quarters.

Recently, Canada’s competition tribunal dismissed a case against Visa and Mastercard thereby upholding their rules prohibiting surcharges on use of credit or debit cards. It dismissed the Commissioner’s appeal to allow merchants to impose surcharge on customers paying by credit cards. This is healthy news for the credit card companies who could have lost on reasonable customer activity had merchants been allowed to impose extra charges for use of cards.

Discovering strength

A few days back Discover Financial Services (NYSE: DFS) posted solid results for the second quarter of fiscal 2013 with EPS of $1.20 per share, comfortably beating Street estimate. In terms of valuation, it is quite cheaper than Visa and Mastercard with a Price to Book Value (PBV) ratio of 2.3 and Price to Earnings Growth (PEG) ratio of 0.88. Discover’s direct banking business picked up good pace in the quarter with a loan growth of around 6%, getting in higher revenue in form of interest income. The interest rates have surged in the last month mainly due to Fed’s decision to taper off the Qualitative Easing (QE) program. I expect the rates to rally further as there is still some uncertainty regarding the QE program, which will prove to be beneficial for Discover as well as other companies in the sector.

Visa is tackling rules well

We know that the U.S lawmakers have invested persistent efforts in reviving the economy with new set of rules and regulations. The Dodd-Frank rules is one of such efforts with the motive of ensuring financial stability. The comforting news is that Visa has successfully adopted the routing rules established under Dodd-Frank. As a result, the company saw positive growth for Interlink payment volume and is also expecting the growth rates would continue to grow for debit card transactions in the future.

Journeying upward

Visa along with other peers is standing right at the onset of a consistent economic recovery complemented by stupendous growth in technology. Moving ahead, Visa will experience reasonable growth fueled by (i) economic recovery and (ii) greater use of plastic money by customers, both online and offline. The positive outlook can be clearly seen in management’s decision to raise guidance on revenue and earnings. The company has raised full year 2013 revenue growth guidance from low double-digits to around 13%. Also, it has announced a $1.5 billion share repurchase program to give back excess cash to shareholders.

A look at the results of major companies in this sector including Visa is good enough to interpret that the industry is getting back on its feet. However, I would definitely pick Visa as a worthy investment because of its moderate valuation and highly optimistic management. This is a good time to build a new position in this stock.

Mihir Mehta has no position in any stocks mentioned. The Motley Fool recommends MasterCard and Visa. The Motley Fool owns shares of MasterCard. 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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