Tailwinds Set to Benefit Credit Companies

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

Are you one of the many shoppers finding yourself using plastic more often?

In some of my recent articles, I've highlighted the financial sector as a beneficiary of rising interest rates with some mention of credit card companies. However, in this article, I would like to focus on the numerous tailwinds set to help some of the largest credit services including Visa (NYSE: V), Discover Financial Services (NYSE: DFS), and PayPal

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Over the last couple of months, interest rates have spiked from their generational lows, largely as a result of market uncertainty. A series of hints, winks, fair flips, whatever you want to call these signals from the Federal Reserve Chairman Ben Bernanke, have caused traders and investment banks alike to finally realize that the end of extremely loose monetary policy may be coming to and end later this year.

If I recall correctly, 2014 has always been an initial estimated target end date for the Federal Reserve, the only difference is in 2011, this end date felt like an eternity away.

While some sectors, including housing, have experienced great turbulence as a result of these rising rates, the financial sector stands ready to finally generate significant net interest incomes. Many of these credit companies were hit badly during the '08 financial crisis as delinquency rates soared over 10% for some in combination with a rise in cash spending. Today, credit quality and delinquency data has improved greatly, helping the profitability of these institutions. 

What's up with Visa

Visa has done very well already this year, in line with broader markets. Shares have moved up 25% year to date on the back of strong delinquency and earnings data. The company generates just over 50% of its revenue from its U.S. business segment, which is expected as in the United States, consumers typically use plastic more often than those in emerging market economies.

However, emerging markets may be the key to sustaining long-term growth. Due to low banking and financial infrastructure, the use of plastic in emerging market economies is significantly lower than in the developed world. In India alone, over 90% of point of sale transactions are done with cash. Within these markets, personal spending has been growing at a steady rate of 10%, thus a 10% growth rate within these countries at a minimum seems likely.

Earlier this year, the company announced that it became the second credit company to issue Yuan denominated credit cards, with the announcement that it predicted the convertibility between the Yuan and base currencies to help grow this segment going forward. Significant growth out of Asia bodes well for overall growth as 30% of its global payment volumes come from this business segment. In the mean time, rising interest rates in the U.S. will help the company generate higher margins ahead.

Looking elsewhere

Earlier this year, Discover Financial Services and eBay (NASDAQ: EBAY) announced an expansion in their payment processing partnership. Back in 2002, eBay acquired PayPal for $1.5 billion. Since then, PayPal and eBay have grown greatly, together. At that time, PayPal was one of the primary payment methods for users on eBay, which it still is today.

However, the service has grown greatly over the last decade. PayPal, with its 128 million active users, is accepted at nearly every online merchant due to its simplicity for both the merchant and customer. Just last year, $128 billion in transactions went through the company's payment service. 

Through the partnership, PayPal and Discover will be teaming up to reach a goal of 2 million accepted processing points by the end of the year. The transition will be simple for retailers. The won't have to make any hardware or software upgrades to accept the PayPal payments, they'll simply have to let customers know of the new option with in-store signage. Going forward, the partnership bodes well for both companies as two different tailwinds will be powering the growth of this partnership.

The first, as mentioned above, is the growth within the plastic payments market across the globe in combination with rising interest rates. The second is the huge potential the deal has in helping the underbanked population in developing countries. While the underbanked population has been overlooked for the last decade, the sheer quantity of these people make the market attractive to any company as far as I'm concerned. 

Recent research shows that 3 billion of us are either unbanked or underbanked due to inadequate infrastructure, primarily in the developing world. However, the smartphone population is rapidly growing within these countries. PayPal would fit perfectly as a mobile banking or wallet application for those who have little access to a traditional bank. Moreover, through the partnership with Discover, these same customers could use their mobile devices as their wallets for payments at merchants who accept Discover plastic. 

Last month, average APR rates ticked up slightly while delinquency rates dropped. Discover reported a 1.58% delinquency rate for May, which came in under the typical 3%-5% rate reported by credit companies. Discover trades at an attractive 10 times its earnings with analysts estimating 9.8% earnings growth going forward. With valuations far below that of the S&P 500, buying Discover here looks like a good bet.

Wrap up

A couple of major tailwinds are set to help these payment services companies. Rising interest rates here at home will help Visa, Discover, and even PayPal. However, emerging markets may be the key driver of growth in the years ahead. All three companies have great potential to capture consumers in the developing world who may be underbanked.

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Nathaniel Matherson has no position in any stocks mentioned. The Motley Fool recommends eBay and Visa. The Motley Fool owns shares of eBay. 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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