Cash or charge, Visa always wins

Share

Add up all the issues facing credit card companies right now, and you might think that the stocks would be symbols of bearish despair.

Yet, Visa Inc. and MasterCard Inc. have done remarkably well for investors – to the extent that they seem to be impervious to the many economic and legal headwinds.

Take a look at Visa. The share price hit a record high on Monday morning, bringing its year-to-date gain to more than 26 per cent.

Like other stocks, Visa was pummelled during the financial crisis, falling more than 50 per cent. However, the share price has since tripled from that 2009 low and is now 45 per cent above it 2008 high, prior to the financial crisis.

And when you look at Visa's revenues and earnings in recent years, you can see a similarly amazing growth trajectory.

Revenue for 2012 is expected to hit $10.3-billion (U.S.), up more than 60 per cent from 2008. Earnings on a per-share basis are expected to rise to $6.09 this year, up 170 per cent since 2008.

That is spectacular growth. But what makes it particularly impressive is that it has occurred despite a dismal-looking operating environment.

Economically this is supposed to be the age of deleveraging, when cash-strapped consumers pay down debt. As well, consumer confidence surveys continue to suggest that Americans – once the world's biggest spenders – are cautious.

The latest University of Michigan consumer sentiment index, released on Friday, fell to 72 in July. The index hasn't improved much over the past three years and is well below readings that were above 90 for several years prior to the financial crisis.

In addition, unemployment remains stubbornly high in the United States and is rising in Europe, where the region is showing every sign of sliding into recession.

Credit card companies are also facing pressure from merchants, who have long been arguing that Visa and MasterCard have far too much control over how they conduct their operations.

On Friday, Visa and MasterCard, along with a some large banks, agreed to a $6.6-billion settlement to end a seven-year old lawsuit with retailers over allegations of price-fixing.

The settlement also cut for a period of eight months the fees that merchants pay to the credit card companies when they accept credit card payments, and allows merchants the right to charge extra for consumers who want to use plastic.

However, this didn't end their woes: the National Association of Convenience Stores has hired New York law firm Constantine Cannon LLP to argue that the settlement doesn't go far enough.

Add it up, and things don't look so rosy for credit card companies on the surface – but the various obstacles beg the question of why their share prices and underlying operations are humming.

Valuations are reasonable, with both Visa and MasterCard trading at about 22-times earnings, or midway within the range of the past several years.

What's more likely is that the plastic payments business is booming at the same time that large credit card companies are enjoying tremendous benefits from their massive size and dominant market share.

In other words, business is booming and there isn't a whole lot of competition.

No wonder Warren Buffett, through Berkshire Hathaway Inc., has invested more than $360-million in Visa.

Mr. Buffett has long preferred companies surrounded by "economic moats," giving them brand-name and pricing-power advantages.

Meanwhile, despite a push back from merchants, it is hard to imagine the world drifting away from what has been a steady trend toward a cashless society.

And as Charles Sizemore of Sizemore Capital Management recently pointed out in a Forbes column, there is still plenty of room for growth. Within the United States, 40 per cent of all transactions are still carried out using cash and cheques – and the U.S. is one of the most plastic-oriented countries in the world.

Of course, many investors have a hard time getting excited about stocks that are at record highs. Here are two possible strategies, though.

One, wait for some really bad economic news – retail sales fall off a cliff or the U.S. slips into recession – then pounce on Visa and MasterCard as the market mistakenly believes that they will suffer long-term damage. They won't.

Two, buy now. If Visa and MasterCard are doing well in spite of all the economic and legal headwinds, imagine where their respective share prices will be when the everything is fine.