Is There Any Upside Left in Credit Cards?

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

The three credit services providers, Visa (NYSE: V), MasterCard (NYSE: MA) and American Express (NYSE: AXP) have all been on a good run during the last few months. However, one has outperformed the others.

Over the last year, Visa has gained 47%, outperforming the S&P 500 (by around 30%) and its closest peers American Express and MasterCard, which have gained 28% and 34% respectively. 

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But is this too much? Is there still upside at Visa or would I be worth looking elsewhere?

Current valuation

Visa processes many more transactions than both American Express and MasterCard put together. Indeed, during the third quarter of 2012, Visa processed 20.5 billion transactions worldwide, way more compared to MasterCard, which only processed 8.6 billion. There are also many more Visa branded cards in circulation, although not as many as the higher number of transactions would suggest.

As of the third quarter in 2012, there were 2 billion Visa branded cards in circulation, while MasterCard only had around 1.86 billion and American Express had only 100 million.

The high number of cards in circulation and transactions processed, indicate that Visa does indeed deserve a premium over its peers. Having said that, Visa's current valuation premium could be greater than it needs to be.

I have used enterprise value, or EV, figures here as they are usually a more accurate measure of valuation, taking into account values of debt and cash balances.

<table> <thead> <tr><th> </th><th> <p>EV/EBITDA</p> </th><th> <p>EV/Revenue</p> </th></tr> </thead> <tbody> <tr> <td> <p>American Express</p> </td> <td> <p>12.3</p> </td> <td> <p>3.7</p> </td> </tr> <tr> <td> <p>MasterCard</p> </td> <td> <p>15.5</p> </td> <td> <p>8.7</p> </td> </tr> <tr> <td> <p>Average Main Peers</p> </td> <td> <p>13.9</p> </td> <td> <p>5.1</p> </td> </tr> <tr> <td> <p>Visa</p> </td> <td> <p>18.3</p> </td> <td> <p>11</p> </td> </tr> <tr> <td> <p>Visa premium over peers</p> </td> <td> <p>32%</p> </td> <td> <p>117%</p> </td> </tr> </tbody> </table>

On both valuation methods, Visa trades at a premium to its peers, and despite the company's higher transaction volumes and larger number of cards in circulation, it is hard to justify the EV/Revenue premium, which is above 100%. On the other hand, the company's EV/EBITDA premium is only 30%, still high but justifiable based on the company's additional exposure.

Future valuation

Elsewhere, it would also appear the Visa trades at a high forward valuation when compared to its peers.

<table> <thead> <tr><th> <p>Company </p> </th><th> <p>2012</p> </th><th> <p>2013E</p> </th><th> <p>2014E</p> </th><th> <p>2015E</p> </th></tr> </thead> <tbody> <tr> <td> <p>American Express</p> </td> <td> <p>18.1</p> </td> <td> <p>16.4</p> </td> <td> <p>15.1</p> </td> <td> <p>14.3</p> </td> </tr> <tr> <td> <p>MasterCard Inc</p> </td> <td> <p>28</p> </td> <td> <p>23.1</p> </td> <td> <p>20.2</p> </td> <td> <p>17.5</p> </td> </tr> <tr> <td> <p>Average Main Peers</p> </td> <td> <p>16.7</p> </td> <td> <p>14.8</p> </td> <td> <p>13.9</p> </td> <td> <p>13.1</p> </td> </tr> <tr> <td> <p>Visa Inc</p> </td> <td> <p>56.8</p> </td> <td> <p>24.7</p> </td> <td> <p>21.8</p> </td> <td> <p>19.1</p> </td> </tr> </tbody> </table>

With such a high future valuation the market is placing an additional premium on the company and its ability to grow.

Historic comparisons

While it is impossible to put a definitive valuation on Visa, it is possible to gauge if the company is overvalued or undervalued based on historic valuations. So, based on the company's EV/Revenue figures over the past five years,

<table> <thead> <tr><th> </th><th> <p>2008</p> </th><th> <p>2009</p> </th><th> <p>2010</p> </th><th> <p>2011</p> </th><th> <p>2012</p> </th><th> <p>5-YR Average</p> </th><th> <p>Current</p> </th></tr> </thead> <tbody> <tr> <td> <p>EV/EBITDA</p> </td> <td> <p>14.9x</p> </td> <td> <p>11.8x</p> </td> <td> <p>10.0x</p> </td> <td> <p>9.2x</p> </td> <td> <p>12.6</p> </td> <td> <p>11.7</p> </td> <td> <p>18.3</p> </td> </tr> </tbody> </table>

it would appear as if Visa is overvalued based on its historic EV/EBITDA ratio. Indeed, over the past five years the company has traded at an average ratio of 11.7. Visa currently trades at a EV/EBITDA ratio of 18.3, which is far above its historic average and makes the company look expensive.

What about the others?

If Visa is expensive, what compelling investment reasons do the other two companies have? Well, American Express offers investors a 1.3% dividend yield, not much but twice the size of Visa's. American Express is also buying back stock to return additional cash to shareholders. The company, according to the valuations above, is also one of the cheapest in the credit services sector.

Meanwhile, MasterCard only offers a 0.4% dividend yield, but the company does have a $1.7 billion share repurchase program in action and a very strong balance sheet with no debt and around $5 billion of cash -- 74% of shareholder equity. Moreover, it would appear as if MasterCard is expanding rapidly in the fast growing African market, and its recent deal with the Nigerian government should be extremely lucrative. 

Foolish summary

All in all, it would appear as if Visa is currently overvalued based on historic valuations and in comparison to the rest of the sector, in my opinion, limiting the stocks upside. MasterCard and American Express, however, both look cheaper based on sector valuations and offer the potential for further upside.

Fool contributor Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool recommends American Express, 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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