(Q.) When is a 10% EPS growth rate a miss?
(A.) When that 10% growth rate is goosed up by a share buyback sufficient to move earnings up by about 1%; otherwise, the core earnings growth rate would have clearly been a sub-10%.
(A). When earnings accretion expected from the consolidation of the European division has, apparently, failed to materialize.
(A). When expenses increased by a far faster rate than earnings.
(A). When earnings from the chief competitor in the space, and a somewhat smaller rival at that, put Visa to shame on every top and bottom line metric.
(A). When analysts and investors are expecting far more and are paying a multiple based on growth and flawless execution.
Visa reported a messy set of numbers for the quarter ended. Revenue increased by 9.9%. Cross board assessments increased by just 9%. Operating expenses increased by 14%. In the United States, where Visa has a dominant market share vs Mastercard, revenue growth in the quarter was just 8.3%. Net income increased by 9.9% year over year; based on the lower share count outstanding, due to buybacks, the 10% EPS increase was, just, met.
What went wrong in the quarter? Visa was careful in the conference call to note the positives. However, they indicated that marketing initiatives and client incentives were the major cost push. Visa has a massive payment processing market share in the United States, more than twice the processing than is produced by Mastercard in the USA. Historically, that market share has been sufficiently large that economies of scale, coupled with a relative lack of competition in the space, has permitted Visa to charge issuing banks more than Mastercard for the right to use the Visa name. Furthermore, Visa has been able to offer lower incentives to card holders than Mastercard. For more than a decade, this has resulted in Visa consistently generating a 6% plus increase in EBITDA as compared to Mastercard, due to a lower expense ledger. While a trend has not yet been made fully apparent, Visa has suggested that client incentive and marketing expense costs should remain high for the balance of 2020, and potentially beyond. This might represent an acknowledgement that the member banks will no longer tolerate the product differential of Visa as compared to Mastercard. Unless Visa offers more more generous terms, there might be some renewals of major agreements at risk in the coming years. In short, it is possible that there will be continued subpar revenue growth, and subpar earnings growth, for a number of quarters to come.
Glossed over by analysts, in the conference call, was the relative lack of momentum from Visa Europe. Visa consolidated this division almost two years ago. The intent was to capture the existing EBITDA from Visa Europe, harmonize systems, implement cost controls and work to increase revenues. To date, it appears that traction hasn’t been easy to come by and there certainly does not appear to be the momentum initially envisioned. Perhaps Mastercard, with a highly dominant position in Europe and an acknowledged willingness to accept lower EBITDA returns, is proving difficult for Visa to dislodge in the space.
In what is, more or less, a global duopoly, Visa routinely produced 6%-8% higher EBITDA rates on every dollar of revenue than has Mastercard. Mastercard has proven to be a highly focused competitor, has captured market share, has grown its data division well beyond pure credit payment processing and has made business purchases generally offering positive EBITDA contributions within one year after purchase. Visa appears somewhat complacent in comparison. Business purchases of Visa tend to offer a two year timeframe before potentially becoming neutral to EBITDA. Visa has failed to grow its data division greatly beyond the core credit processing space.
Perhaps, in the year to come, a valuation risk is now coming to light. Does a company with a 9% core growth rate, an expense growth rate well beyond that and a less than focused acquisition policy deserve a multiple of 30X EPS? Based upon the current quarter and a warning in increased expenses, street consensus on earnings look to be too high and may need to be adjusted accordingly. There is also some potential for acquisition risk. The newest deal by Visa, with an estimated capital outlay of $5 billion US, does not seem, to my thinking, to have any synergies and carried a nosebleed valuation to top it off. If Visa management feels pressured to buy, simply for the sake of buying, then all of that EBITDA benefit from its size, might get wasted on poor acquisitions.