Published on June 3rd, 2018 by Bob Ciura
The major U.S. payment processor stocks are on a roll. In the past 5 years, shares of Visa (V) and MasterCard (MA), have generated annual returns of 24.9% and 28.1%, respectively. Both stocks have trounced the broader market in that time, as the SPDR 500 ETF (SPY) has returned 12.9% in that time.
The third-largest payment processor by market capitalization, American Express (AXP), has generated annualized returns of 6.9% in the past 5 years, which is still a respectable rate of return given the company struggled through the loss of a major customer.
Visa, MasterCard, and American Express are in Sure Dividend’s database of financial-sector stocks. You can download the full list of all 1,000+ dividend paying financial sector stocks below.
They also rank highly in the Sure Analysis Research Database. We expect annual returns of 10%+ for all three stocks going forward, mainly because they are benefiting from a major structural shift.
The U.S. is increasingly moving towards a cashless society. Consumers, particularly among younger generations, are much more comfortable performing financial transactions without using cash.
This article will discuss the economic and social trends that have caused a modern-day gold rush for the three largest U.S. payment processors.
Payment Processor #1: American Express
- Expected Returns: 11%-12% Per Year
American Express was founded in 1850, and currently has a market capitalization of $85 billion. It has a diverse business model in terms of customer type and geographic markets.
Source: 2018 Investor Day, page 12
The company had struggled in recent years, due to the loss of its major customer, Costco (COST). Ameican Express had issued Costco co-branded cards, but sold the portfolio to Citigroup and Visa. As a result, American Express reported revenue declines in 2015 and 2016. Fortunately, the company has returned to growth. Revenue and earnings-per-share both increased 4% in 2017.
The company is off to an even better start to 2018. On 4/18/18 American Express announced first-quarter earnings. The company reported revenue of $9.7 billion, up 12% year-over-year. Earnings-per-share of $1.86 were an increase of 38% from the same quarter a year ago. Both figures handily surpassed estimates. Revenue and earnings-per-share beat analyst expectations by $580 million and $0.15, respectively.
During the quarter, American Express recorded billed business growth of 10%, an acceleration from an already strong pace from 9% in the previous quarter. Billed business increases are a major driver of growth for American Express, as is interest income, which grew by 23% last quarter thanks to 16% loan growth.
For the full year, American Express expects earnings-per-share to reach the high end of its previous guidance, which is a range of $6.90 to $7.30 per share. At the midpoint of guidance, American Express expects 21% earnings growth for 2018. Revenue is expected to grow 8% for the year. Share repurchases are an additional catalyst for earnings growth. American Express generates lots of cash flow, which allows the company to buy back its own stock. The company reduced shares outstanding by 5% in 2017, and will resume its buyback program in the 2018 third quarter.
There should be plenty of runway for American Express to continue a high rate of growth moving forward. Penetration rates for card addressable spend is still fairly low around the globe, which leaves ample room for growth, particularly in the consumer segment.
Source: 2018 Investor Day, page 23
Growth is particularly tempting in the emerging markets. For example, on 4/26/18 The Wall Street Journal reported that American Express could become the first U.S. card network to enter China. The People’s Bank of China approved its application to clear and settle domestic bank-card transactions, through a joint venture with Lianlian Group. This could be a huge catalyst for American Express, as China is a high-growth economy with a population exceeding 1 billion.
One potential risk for American Express would be a global recession. As a financial services company, American Express is negatively impacted by economic downturns. For example, during the Great Recession, the company experienced a 38% earnings-per-share decline in 2009. Financial services is a cyclical industry that relies on a healthy economic climate for growth. During recessions, people tend to reduce credit card spending, which means another recession would significantly impact the company’s earnings growth.
If the global economy stays out of recession, we expect a high rate of return for American Express. The stock currently trades for $99. We have a fair value price of $101, meaning the stock is only slightly undervalued right now. That said, the stock can generate positive returns through earnings growth and dividends. With 10% annual returns expected from valuation changes and earnings growth, dividends will provide a boost to returns.
American Express has a current dividend yield of 1.4%, and the dividend is highly secure. Using 2018 company earnings estimates, American Express is likely to have a dividend payout ratio below 20% for this year. This leaves plenty of room for high dividend growth, such as the 9.4% dividend increase approved last year. Including valuation changes, earnings growth, and dividends, we expect total returns of 11%+ per year for American Express stock.
Payment Processor #2: Visa
- Expected Returns: 10-11% Per Year
Visa Inc. is the result of the merger of Visa USA, Visa International, Visa Canada, and Inovant. The companies came together in 2007. In March of 2008, Visa Inc. conducted its initial public offering, or IPO. It raised $17.9 billion, and it was the largest IPO in U.S. history at the time.
Today, Visa is a global payments giant, operating in over 200 countries around the world. The stock has a market capitalization of $293 billion and the company generates annual revenue above $18 billion.
For the 2018 fiscal-second quarter, Visa grew its net revenues by 13% and its adjusted earnings-per-share by 30% from the same quarter a year ago. Both figures beat analyst estimates. Revenue of $5.07 billion beat expectations by $260 million, while adjusted earnings-per-share of $1.11 beat by $0.09 per share. High growth rates for cross-border and payment volume fueled the impressive quarterly performance for Visa.
Source: Earnings Presentation, page 5
Payments volume continues to grow at a double-digit pace, in the U.S. and internationally. In addition, transactions grew 10% from the same quarter a year ago. The number of cards issued also rose 4% last quarter, including 2% growth in credit cards and 5% growth in debit cards.
To summarize, not only are consumers obtaining more debit and credit cards, they are using their cards in greater frequency. These trends have resulted in high revenue growth for Visa. Margins are also expanding, as Visa’s services revenue increased 13% to $2.3 billion, while operating expenses rose just 4% last quarter. This has led to Visa’s strong earnings growth.
Source: Earnings Presentation, page 10
Along with results for the most recent quarter, Visa also raised full-year guidance. For fiscal 2018, the company expects low-double digit revenue growth, and 20%+ earnings growth. Going forward, growth will be fueled by global expansion of the payments industry. Visa will supplement its organic growth with acquisitions.
For example, on 3/7/18, the company acquired Fraedom, a Software-as-a-Service technology company that provides payments and transaction management solutions for financial institutions. The acquisition will expand Visa’s business solutions segment, to further reach into the high-growth business-to-business market.
Visa is a dividend growth company. It has increased its dividend in two out of the past three quarters. The most recent quarterly dividend payment of $0.21 per share was 27% higher than the same quarterly payout last year. Visa is certainly a low-yielding dividend stock, with a current yield of just 0.6%. A yield below 1% is not likely to make the stock attractive for income investors.
Visa might not have appeal for retirees, but investors with a time horizon beyond a few years, should see a lot of potential for future dividend income. If Visa continues to increase its dividend by 20% compounded annually, its dividend would double every 3.6 years. For investors willing to be patient with Visa’s low current yield, the long-term rewards could be significant.
When it comes to valuation, Visa stock admittedly holds a high valuation. Based on our estimates of $4.40 in fiscal 2018 earnings-per-share, Visa stock currently trades for a price-to-earnings ratio of 29.7. A price-to-earnings ratio of nearly 30 is a high valuation, even for a growth company. Our fair value estimate for Visa is a share price of $102, which implies 22% downside.
However, we believe Visa’s earnings growth and dividends can more than make up for overvaluation. Even with expectations for valuation changes to negatively impact total returns by 5% per year, we expect 15% annual earnings growth. Adding in the 0.6% dividend yield, total returns are expected to exceed 10%+ per year.
Payment Processor #3: MasterCard
- Expected Returns: 10% Per Year
MasterCard, Inc., was founded in 1966 when a group of banks formed the Interbank Card Association. In 1969 this group purchased the rights to use the “Master Charge” brand from the California Bank Association. In 1979, the group was renamed MasterCard. The company went public in 2006.
Today, MasterCard has a market capitalization of $204 billion, and the company operates in more than 210 countries and territories around the world. It had almost 2.4 billion credit and debit cards in use as of the 2018 first quarter.
On 5/2/18, MasterCard reported 2018 first-quarter results. It was a hugely successful quarter for MasterCard, as the company reported record first-quarter revenue and net profit. Revenue increased 31% to $3.6 billion, while adjusted earnings-per-share increased 43% excluding foreign exchange. MasterCard blew away estimates for the quarter. Revenue beat analyst targets by $330 million, while earnings-per-share beat by $0.26.
All three of MasterCard’s main revenue-generating businesses showed impressive growth last quarter. Revenue increased 20% in domestic assessments, 19% in cross-border volume fees, and 22% in transaction processing fees. The company saw broad-based growth across geographic segments. For example, gross dollar volume increased 12% in the Asia-Pacific, Middle East & Africa segment, and increased over 20% in Europe and Latin America last quarter.
The main drivers of MasterCard’s excellent quarterly performance, were higher transactions and cards issued. Transactions rose 17%, while card growth was 6% for the quarter. This led to 14% global gross dollar volume growth last quarter, including 10% growth in the U.S. and 16% growth internationally.
Source: Earnings Presentation, page 4
For 2018, MasterCard expects revenue growth in the mid-teens on a percentage basis. Operating expenses are expected to rise in the high-single digits, which implies the company should see meaningful operating margin expansion this year. As a result, it is not unreasonable to expect 20%+ earnings growth for MasterCard this year.
MasterCard has grown earnings per share at a rate of almost 18% per year over the past 10 years. We currently forecast an earnings growth rate of 15% per year, over the next five years. The major risk to this growth forecast would be a global recession, although MasterCard proved to be surprisingly resilient during the last recession. During the Great Recession of 2007-2009, MasterCard actually grew earnings consistently throughout the downturn. The company increased earnings-per-share by 24% in 2009, and continued to grow earnings every year since.
MasterCard is a very shareholder-friendly company. The company returns a great deal of cash to shareholders through buybacks and dividends. For example, last quarter MasterCard repurchased 7.9 million shares for $1.4 billion, and paid dividends of $263 million. The company has $3.3 billion of share repurchases available under the current buyback authorization, which will help boost future earnings growth.
As MasterCard grows earnings-per-share, its dividend will also grow at a high rate. MasterCard has increased its dividend per share for only the last 7 years, but it has paid an uninterrupted dividend since 2006. Dividends have grown at nearly double the rate of earnings growth in the past 10 years.
While MasterCard has a relatively unattractive current dividend yield of 0.5%, like Visa it can reward patient shareholders with high dividend increases. We currently forecast a payout ratio under 20% for MasterCard, which leaves plenty of room for high dividend growth.
We currently view MasterCard as the most overvalued of the 3 major U.S. credit card processors. Our fair value estimate for MasterCard stock is a share price of $140, compared with a current share price of $195. As a result, we believe valuation changes will reduce shareholder returns by approximately 6% per year, over the next five years.
That said, we still view MasterCard as a strong pick for dividend growth investors. The company is expected to grow earnings-per-share by 15%-16% per year. In addition, the stock has a dividend yield of 0.5%, which will slightly add to shareholder returns. Overall, our expectation is for MasterCard stock to generate annual returns of 10%.