Why Visa Could Be A Better Investment Than Mastercard

Summary:

• Visa Inc. and Mastercard Incorporated are among the highest quality, non-cyclical businesses money can buy today.
• Benefiting from ever-increasing M2 supply, move towards a cashless society and elevated inflation, both businesses are expected to continue growing quickly.
• The low dividend yield is well compensated for by the double-digit DGR and the yield on cost could be over 3% in 10 years’ time.
• Given the quality, both trade at a premium valuation, yet Visa offers better risk-adjusted ROI even with lower forward EPS growth.

Are you looking for a dividend growth company to add to your portfolio?

You do not need to look much further than the two payment processing companies, Visa Inc. (NYSE:V) and Mastercard Incorporated (MA).

Both of the companies are among the highest quality businesses that money can buy today with non-cyclical, resilient business models, benefiting from tailwinds such as ever-increasing M2 supply and move towards a cashless society.

While the yield for each of these companies is <1%, the DGR well compensates for the lack of yield for investors which are willing to wait. The dividends are expected to grow at around 10% to 15% annually over the next decade and the yield on cost in 10 years may be >3% or higher.

Alongside the stunning dividend growth rate, the companies have delivered extraordinary returns, placing them among the best-performing S&P 500 (SP500) companies of the past decade.

However, the duopoly-like position of these two juggernauts has attracted also the attention of lawmakers which may potentially be harmful to the growth of these two richly valued companies.

Let me show you why I think both Visa and Mastercard are among the best businesses one can buy today, and why I think Visa will outperform Mastercard over the next couple years.

Business Overview

Visa and Mastercard are both established players in the payment processing industry, with majority of the market share, operating a duopoly domestically and internationally.

At a first glance, the business model of each of the companies is rather straight forward, facilitating safe payments between consumers and businesses.

During the payment process, the payment’s processor secure network acts as a middleman, ensuring safe transfer of funds from consumer’s bank to the merchant’s.

This business model is very similar to a toll system, charging a small fee ranging from 1.5% to 3%, depending on the type of transaction. The fee is not paid directly by the consumer, but instead by the merchant, while portion is being split with the card issuing bank. While consumers do not pay the fee directly, naturally we can expect that the price of the goods bought includes the hidden fees.

The size of the fees varies, depending on the type of card used, domestic or international transaction, FX involvement, yet the main principle of the revenue model remains the same for the both Visa and Mastercard.

In a major move, Visa and Mastercard have now agreed to cap credit card processing fees in order to reduce the pressure on U.S. merchants, which are largely comprised by small businesses. Just in 2023 alone, U.S. merchants handed over $100.8 billion in credit card fees.

Over the next couple years, the fees should reduce by 4/100th of a percentage point, elevating some pressure from the merchants, yet not causing damage to the payment processing companies. For more flexibility in pricing, merchants will be able to adjust prices of products bought by a credit card in 96% of transactions, up from less than 20% before.

Due to the monopoly like position, little CAPEX spending needed to maintain the networks, asset-light operations and high profitability, the payment processing companies are prime example of perfect business models, which every investors should own in their portfolio, even though they rarely trade a discount.

While neither Visa nor Mastercard are “get rich overnight” stocks and owning them is about a patience instead, the move towards cashless society induced by COVID-19 pandemic, staggering increase in the U.S. money supply or “M2” by 84.6% in the past decade alone, alongside high inflation since 2021, are factors which are artificially helping these businesses to bring more revenue through fees. Naturally, the market share and number of transactions is key to the success, but ever increasing size of transactions, automatically means higher absolute fees, which are in return driving the top and bottom line.

Visa was initially founded by Bank of America (BAC) back in 1958, and today, being a standalone company, is valued at $554 billion.

Mastercard, the younger of the two, was founded by the Interbank Card Association in 1966 and is valued now at $445 billion.

Each of the companies is a mature business, with nosebleed profitability. Thanks to the very minor COGS, and non-cyclical costs, Visa has a gross margin of 81%, while Mastercard reaches 77%, dragged a bit by higher promotional spending.

To give you a perspective, the average S&P 500 company during the Q4 2023 reported a gross margin of 45%, which underscores how highly profitable these two businesses are and that Mastercard has some catching up to do.

You may be thinking the elevated profitability would automatically attract new entrants into the industry, potentially pressuring Visa and Mastercard in the future, similar to what we could see with companies such as PayPal (PYPL) and Block (SQ), where profitability has been under pressure in a very competitive industry.

It’s key to understand that building a similar payment network in today’s complex regulatory environment, is virtually impossible. The regulations in place, by design, effectively ensure a duopoly for Visa and Mastercard, preventing new entrants, yet attracts unwanted attention by the government.

The discussed, processing fees litigation, which has been ongoing for decades and recently settled with little risk for the payment companies, highlights the risk of unwanted attention by US lawmakers and potentially stricter regulations in the future, which could eventually harm the business.

One of the major advantages that both Visa and Mastercard hold over other financial businesses is the limited CAPEX spending needed to maintain or upgrade the payment processing networks. In fact, Visa spent only $0.2 billion in network expenses in Q1 FY24, while earnings $8.6 billion in net revenue.

Majority of the expenses incurred by both companies are instead personnel, similar to software companies. The limited spending, high profitability ensures the businesses carry little to none leverage and currently Visa has only $2.1 billion of net financial debt, with “AA-” credit rating by S&P Global.

Mastercard is slightly more leveraged with $6.5 billion of net debt, yet the company receives “A+” credit rating.

The little debt on balance sheet, signifies major financial strength of both companies with changes of going bankrupt over the next 30 years lower than 5%, yet I prefer Visa’s lesser leverage.

Given the high barriers to entry the industry due to the complex regulations, it’s no surprise that few companies dominate the market share. Union Pay from China, Visa and Mastercard control roughly 97% of the global credit card transactions.

Union Pays keeps its transaction volume confidential, but we get a clear picture of the market share, using the domestic market share data from 2022:

• Visa has dominated the market share with 61% and $5.83 trillion in transaction volume.
• Mastercard is the 2nd largest domestic payment processing company with 26% market share and $2.18 trillion in transactions.
• American Express (AXP) follows in 3rd with 11.3% market share and transaction volume of $1.08 trillion.

To give an idea of the size of industry, in the U.S., 70% of adults carry at least one credit card. That is a staggering 184 million of individuals.

When we look at the international payment processing market share, Visa is still in a dominant position with 34% of market share, but the gap to Mastercard shrinks as the company has 23% of the market.

The longer presence of Visa in the domestic market has led to capturing a significant portion of the market, which is very hard for Mastercard to win over as individuals have little incentive to switch from one provider to another without major benefits, that’s why also Mastercard spends more on promotions compared to Visa, hence lower profitability.

Instead, Mastercard is focusing more on the growth of the market share in international space, where the market is not yet so saturated and more people are switching from cash to card payments.

The market share is one of the key metrics for the industry as more cards in the system, the better for the processing companies, giving Visa edge.

Yet, where Mastercard shines is how effectively the company uses its capital to generate profits. Being smaller, Mastercard is more versatile and more inclined to deploy the capital and keep driving the growth in the future.

Looking at the Return on Investing Capital or “ROIC”:

• Mastercard’s ROIC (past 5 years): 48.1%
• Visa’s ROIC (past 5 years): 24.3%.

Dividend Growth Superstars

Visa and Mastercard are both very attractive investment options for dividend growth investors. The initial dividend yield <1% may prompt some investors to automatically avoid them, but the double-digit DGR of the past decade well compensates for the lack of yield and with the expectation to continue growing anywhere between 10% to 15% annually over the next decade, will eventually lead to reasonable yield on cost of >3% in 10 years’ time.

Visa currently pays $0.52 dividend or 0.74% dividend yield. Since 2015, the dividend grew 420%, which translates to yield on cost of 3.77%. The last dividend increase came in October 2023 with 15.6% raise.

Mastercard currently offers slightly lower dividend yield of 0.56% or $0.66 per share, however the dividend grew a bit faster, by 500% since 2015. Similarly to Visa, since 10 years ago, the yield on cost grew to reasonable 3.46%. Mastercard announced their dividend increase in December 2023, by 16%.

If the yield or the DGR does not satisfy you, the buybacks may. Over the past decade Visa has repurchased back close to 19% of its shares based on the diluted basis and Mastercard has repurchase almost 20%, further rewarding its shareholders.

Quality Comes At A Price

After using many superlatives of how great the business model is, record-breaking profitability and little to none debt, you already guessed that neither of the companies are going to be trading at a cheap valuation.

Since 2008 both companies grew their EPS at a very similar rate. Visa grew its EPS annually by 18.32% and Mastercard at 18.31%.

If we shorten the duration and consider the data only since 2015, we can see that Mastercard have outperformed Visa in EPS growth. Mastercard delivered 17.11% EPS growth, compared to Visa’s 15.47%.

This trend is expected to continue as analysts polled by S&P Global forecast Mastercard’s EPS growth to be around 16.75%:

• 2024: EPS of $14.46E, YoY growth of 18%
• 2025: EPS of $16.81E, YoY growth of 16%
• 2026: EPS of $19.50E, YoY growth of 16%.

Visa’s expectations are a bit more muted, with around 13.75% expected growth:

• 2024: EPS of $9.94E, YoY growth of 13%
• 2025: EPS of $11.22E, YoY growth of 13%
• 2026: EPS of $12.75E, YoY growth of 14%.

These expectations confirm that Mastercard is more aggressively investing in its growth and given the smaller size, the company is more versatile to deploy its capital as shown by the ROIC.

Yet, growth is only half of the valuation equation. We need to look at the P/E to understand which company trades at a larger premium.

Mastercard is currently valued at a blended P/E of 37.2x, compared to historical average of 34.2x its earnings, implying significant premium without any margin of safety.

If the expected growth materializes and the valuation contracts towards its historical average as I would expect, investors are still poised to see total ROI of around 13.5%, but with little margin of safety with the stock trading at rich premium.

Visa’s lower growth expectations naturally come with “cheaper” valuation of 29.6x its blended P/E, more in-line with its historical valuation of around 30.6x its earnings.

Given the stock is not trading at stretched levels compared to Mastercard, investors should expect better risk-adjusted returns while sleeping better at night, with some degree of margin of safety.

Buying high-quality business like Visa at or below 30x its earnings is rather a rare opportunity and if the growth materializes, investors can expect up to 15.4% annual total ROI on their investment over the next three years.

While the 1.9% annual ROI difference compared to Mastercard may not sound like much, the risks are significantly lower and in case of general market pullback I expect Visa to hold up better, with limited downside risk.

Takeaway

Visa and Mastercard are among the highest quality blue chip companies that investors can buy today.

The non-cyclical, resilient business model, which acts a toll system on world’s financial transactions is experiencing major tailwinds by the ever increasing M2 supply and move towards a cashless society.

Both companies are highly profitable, mature businesses with little to none financial debt and no need to invest heavily in maintenance or upgrades of its payments networks.

The high barriers of entry into the industry, led virtually to creating of duopoly which on one hand side ensures a stability for the two juggernauts, yet it attracts the attention of lawmakers with potential stricter regulations on capping credit card fees in the future.

Each of the two companies is expected to grow its EPS by double-digit rates over next three year and given its qualities, each trade at a premium valuation, however Visa Inc. is expected to deliver higher ROI, given the company trades more in-line with historical valuation, offering investors better margin of safety and cushion in case of general market pullback.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of V either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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