Visa's (NYSE: V) stock has risen 24% during the past three years as the S&P 500 advanced 19%. If we include reinvested dividends, the payment-processing giant generated a total return of 27% compared to the S&P 500's total return of 25%.
Visa stayed ahead of the market even as it grappled with inflation, slower consumer spending, and pressure from merchants to lower its swipe fees. But can this financial juggernaut continue to outperform the market during the next three years?
A resilient business model
Visa doesn't issue any credit cards of its own. It only partners with banks and other financial institutions to issue Visa-branded cards, and those partners actually shoulder all the debt and collect the payments.
Image source: Getty Images.
Visa is only responsible for routing those payments through its global network, and it charges businesses a swipe fee of about 1.5% to 3.5% for every transaction. It then splits that fee with the card issuer and retains the rest as revenue. Mastercard (NYSE: MA) uses a similar business model, but American Express(NYSE: AXP) operates a more capital-intensive model by issuing its own cards and taking on its customers' debt.
Visa and Mastercard hold a near-duopoly in the card-payment market, so most businesses still begrudgingly pay the swipe fees for the convenience of their customers. From fiscal 2020 to fiscal 2023 (which ended last September), Visa's revenue grew at a compound annual growth rate (CAGR) of 14% as its earnings per share (EPS) increased at a CAGR of 19%.
But Visa still faces some challenges
Visa still has plenty of room to grow as fewer businesses accept cash payments, but it isn't immune to macro headwinds. If inflation or an economic slowdown curb consumer spending, its transaction revenue will decline. That's why its revenue fell 5% in fiscal 2020 (its only year-over-year decline since its initial public offering, or IPO, in 2008) during the onset of the COVID-19 pandemic.
Visa could also face competition from newer digital-payment platforms. Buy now, pay later (BNPL) services like Affirm(NASDAQ: AFRM) let customers break up their payments for purchases into smaller installment plans instead of using credit cards, and digital-payment platforms like PayPal(NASDAQ: PYPL) can be tied to bank accounts instead of cards. The Federal Reserve even launched its own instant-payment system, FedNow, as an alternative to card-processing networks last year.
Another headwind could come from the various merchant groups which have pressured Visa and Mastercard to reduce their swipe fees over the past two decades. This March, the two companies finally negotiated a preliminary deal with those groups to reduce their swipe fees by at least four basis points (0.04%) during the next three years, but a federal judge unexpectedly rejected the settlement in June. That setback indicates the regulators want Visa and Mastercard to reduce their fees even more, and that pressure could significantly throttle their revenue growth and squeeze their gross margins.
What will happen during the next three years?
I believe three things probably will happen during the next three years. First, interest rates should decline and give a lift to consumer spending. Second, Visa and Mastercard should remain the leading payment-processing networks even if some younger or lower-income consumers pivot toward BNPL services or digital-payment platforms which aren't tethered to cards. Lastly, Visa and Mastercard will probably need to cap or reduce their swipe fees to appease antitrust regulators.
In other words, Visa will benefit from some economic tailwinds but face some regulatory challenges. I think the former should offset the latter and enable it to grow at a steady rate during the next three years. From fiscal 2023 to fiscal 2026, analysts expect its revenue to grow at a CAGR of 10% as its EPS increases at a CAGR of 14%. Its stock still looks reasonably valued at 25 times forward earnings, but its paltry forward dividend yield of 0.7% won't attract any serious income investors.
Assuming Visa matches analysts' expectations, increases its earnings another 14% in fiscal 2027, and still trades at the same multiple, its stock price could reach about $350 by the final year. That would represent a gain of 25% from its current price.
Visa isn't a high-growth stock, but it's still a fairly safe way to profit from cooling interest rates and a warming economy. Investors should just keep a close eye on the unpredictable regulatory challenges and their impact on its near-term growth.
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American Express is an advertising partner of The Ascent, a Motley Fool company. Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Mastercard, PayPal, and Visa. The Motley Fool recommends the following options: long January 2025 $370 calls on Mastercard, short January 2025 $380 calls on Mastercard, and short September 2024 $62.50 calls on PayPal. The Motley Fool has a disclosure policy.
