Thursday, June 30, 2011

2 Reasons to Buy, 2 to Wait on Visa Stock

Visa (NYSE: V) stock was up 15% Wednesday after the Federal Reserve approved higher than expected debit card fees. Should you buy the stock now or does its current price reflect all its upside earnings potential?

The Fed was expected to limit so-called debit-card swipe fees, also known as interchange fees -- paid by merchants and pass the money to card issuers -- to 12 cents a transaction. The pleasant news for investors was that the Fed actually approved a 75% higher 21 cents per transaction limit, effective October 1.

The bad news is that the new interchange fees will be less than the old average of 1.14% of the purchase price. But since the fee was higher than investors expected, Visa stock rose.

There are two good reasons to buy Visa stock:
  • Long-term financial strength. Visa's revenues of $8.6 billion have risen at a 24.8% average annual rate in the last five years while its profits soared at a 62.1% annual rate to $3.3 billion -- yielding a high 37.7% net profit margin. Visa has a tiny speck of long-term debt -- 0.1% of equity and its cash balance has increased at a 44.4% annual rate from $931 million in 2006 to $4,051 million in 2010. 
  • Strong second quarter earnings. In the quarter ending March 2011, Visa's operating earnings of $1.23 per Class A common share were three cents more than Zacks Consensus Estimate. Visa's revenues rose 14.6% to $2.25 billion, 1% more than Zacks Consensus Estimate of $2.23 billion.
There are also two pieces of mixed news:
  • Visa stock is not cheap. Visa trades at a price-to-earnings-to-growth (PEG) ratio of 1.24 (where 1.0 is considered fairly valued). Visa’s P/E is 19.3 on earnings expected to climb 15.6% to $5.68 a share in 2012.
  • Progress in trying to earn more than its capital cost. Visa does not earn enough in after-tax operating profit to offset its cost of capital. But it is getting much closer. After all, it’s producing positive EVA Momentum, which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales. In 2010, HP’s EVA momentum was up 9%, based on 2009 revenue of $6.9 billion, and EVA that improved from negative $704 million in 2009 to negative $69 million in 2010. If its EVA Momentum continues at this rate, it looks like Visa will generate positive EVA in 2011.
My conclusion is that Visa is a very strong company whose stock I would consider buying on a market dip. With the volatility I expect during July negotiations on the debt limit, it would not surprise me to see some big down days on the market. And those days might be good ones to consider picking up Visa at a lower price.


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