Visa is a somewhat unique company in that it is a longtime, established market leader that still enjoys strong growth prospects. Despite the ongoing evolution in the payments industry, we think a wide moat surrounds the business and that Visa’s position in the global electronic payment infrastructure is essentially unassailable.

The shift toward electronic payments has aided Visa’s growth historically, and we expect that to continue for the foreseeable future. Digital payments, on a global basis, surpassed cash payments just a couple of years ago, suggesting this trend still has a lot of room to run. We think emerging markets could offer a further spurt of growth even if growth in developed markets slow. Visa’s position as the leading network makes it something of a tollbooth business, and the company is relatively agnostic to the smaller shifts within electronic payments, since it earns fees regardless of whether payment is credit, debit, or mobile.

Visa is not without its issues in the near term, and its smaller peer, Mastercard, has been performing better over the past few years. Cross-border transactions, which are particularly lucrative for the networks, have seen dramatic declines due to the coronavirus outbreak and a reduction in global travel. We expect this headwind to endure for some time, but history suggests travel ultimately makes a full recovery following disruptive events and we expect that to be the case again, although the process could take a few years.

Visa obviously has sensitivity to the volume of consumer transactions, and the U.S. remains its largest market. A downturn in the economy would slow growth, and the fallout from the coronavirus has had a material impact, with both card networks seeing major declines in transaction volumes, although that pressure has steadily eased over time. However, we don’t see any long-term industry trends that will impede Visa’s ability to maintain its growth in the coming years, and the scalability of the business should still allow the company to modestly expand its already ample margins over time.

Payment networks such as Visa benefit, unsurprisingly, from a network effect. The more consumers that are plugged into a payment network, the more attractive that payment network becomes for merchants, which in turn makes the network more convenient for consumers, and so on. This explains why a handful of networks have come to dominate electronic payments, and at this point, Visa has reached essentially universal acceptance in most developed markets. While the network effect is the initial and primary driver of economic moats in this industry, the highly scalable nature of payment processing leads to sizable cost advantages for large payment networks, which in turn further cements their competitive positions. For the dominant payment networks with global footprints, such as Visa, the network effect and resulting cost advantage is strong enough to lead to a wide moat, in our view.

Visa traces its roots back to the issuance of the first Bank of America cards in the late 1950s. As credit cards grew, partnerships between credit card issuers became necessary, and Visa as a brand was formed in 1976. In the decades since, Visa has been one of the largest beneficiaries of the shift toward electronic payments. In fiscal 2020, the company processed almost $9 trillion in purchase transactions. Visa has almost 16,000 financial institution partners, 3.4 billion Visa cards in circulation, and over 50 million merchants accepting Visa. According to the Nilson Report, Visa holds over 50% market share (by purchase volume) in the U.S., Europe, Latin America, and the Middle East/Africa. Visa also processes roughly twice as many transactions as its closest competitor, Mastercard. Simply put, Visa’s position in the world of electronic payments is unparalleled. We don’t believe that building a new network with a comparable size and reach is realistic over any foreseeable time line, and view Visa’s position within the current global electronic payment infrastructure as essentially unassailable.

Visa has translated its dominant competitive position into an enviable level of profitability. Operating margins (using net revenue) in fiscal 2020 were 65%, and margins have generally trended upward because of the scalability of the business. Further, given the relatively asset-light nature of the business, returns on invested capital are quite healthy, averaging 27% over the past five years and 44% if goodwill is excluded.

We are increasing our fair value estimate to $215 from $208 per share, due to time value since our last update and some modest changes in our assumprions. Our fair value estimate equates to 37.1 times adjusted projected fiscal 2021 earnings. While growth recently has been muted due to the economic impact of the coronavirus, particularly due to the impact on cross-border transactions, we expect recovery over time and think the ongoing shift toward electronic payments will allow Visa to maintain strong growth rates over the next five years and project gross and net revenue to grow at a 13% CAGR. We think that this growth will be increasingly driven by international markets, as emerging markets become a more meaningful engine for the business. While margins on a gross revenue basis have stalled in recent years and have been under pressure over the past year, we think the scalability of the business and more muted client incentive growth will allow for margin improvement going forward, and project operating margins (based on gross revenue) to improve from 49% in fiscal 2020 to 56% by fiscal 2025. Given the company’s history of fines and one-time charges, we include ongoing one-time costs roughly in line with historical averages in our projections, but these costs are excluded from the margin levels above. We use a 9% cost of equity.

Visa’s revenue is tied to the amount and volume of consumer purchases, which creates macroeconomic sensitivity. Both Visa and Mastercard have paid substantial fines historically related to the oligopolistic nature of the industry, and legal and regulatory risk is intrinsic to the business model, given merchants’ desires to lower fees. While Visa’s and Mastercard’s positions in the current electronic payment industry are largely set, it continues to evolve in ways that could reduce their volume or profitability. Some governments have shown a preference for local payment networks, which could freeze Visa out of certain markets and impede the value it drives from its global network.

We see the company's largest ESG risk as data security. Any company involved in processing payments has potential exposure to breaches in its systems.

Our capital allocation rating for Visa is Standard. In our opinion, the company’s balance sheet is sound, its capital investment decisions are fair, and its capital return strategy is appropriate.

We attribute the company's strong historical performance primarily to the wide moat around the business and favorable secular trends. That said, management deserves credit for avoiding any major hiccups and steering a fairly steady and profitable course. Alfred Kelly Jr. has been CEO since 2016 and served as a director since 2014. Before joining Visa, the bulk of his career was spent at American Express, where he oversaw a number of that business’ segments. We like that he has a wealth of experience managing payment networks, and we think management has largely charted a wise course.

Management has made one big move in recent years. In 2016, the company acquired Visa Europe for about $20 billion. Visa historically had been operated as a joint venture of issuer banks. When Visa reorganized in 2007, Visa Europe retained this old structure, and the acquisition brought this situation to a close. We think consolidating the global network was a wise but somewhat inevitable move, and the integration in the years since has largely gone smoothly, with management declaring the process effectively finished in fiscal 2018.

Like Mastercard, Visa has been very active in returning cash to shareholders, with dividends and stock buybacks over the past three years equating to 90% of free cash flow over that period. We like that management is largely content to return the company’s ample profits, but question whether a shift toward a higher dividend could make management's commitment to capital return more clear. Barring the Visa Europe acquisition, which was a unique situation, Visa has avoided large-scale M&A. We think this is wise, as the company’s competitive position makes M&A somewhat unnecessary, and its position in the industry requires maintaining a fairly neutral stance toward other payments areas, to avoid unnecessary competition with other players within its ecosystem.