There are numerous reasons to love Visa (NYSE: V) and Mastercard (NYSE: MA). One that certainly stands out these days, though, is that both companies benefit significantly from a highly-inflationary environment. In fact, high inflation levels can contribute to accelerating earnings growth, moving forward. Nevertheless, the market seems to have largely priced in this upside, which is why I am neutral on both names.
Why Elevated Inflation Rates Favor Visa and Mastercard
Inflation’s Effect on Revenues
Primarily, high inflation rates benefit both Visa and Mastercard because the two payment processors charge the same fee percentage in each transaction, but it is applied at a higher nominal price. Every morning, you pass by your favorite bakery to buy your daily coffee, but you are likely paying anywhere from 5% to 20% more for that coffee compared to what you were paying last year. Also, every time you swipe your card, Visa & Mastercard collect fees which are now higher by an equally-high increase to the price you paid compared to last year.
Just like that, without any change to their business model, Visa and MasterCard are set to keep growing their top lines by at least the pace of inflation, all other factors equal. This is the benefit of essentially running a virtual toll booth for every single daily transaction, whether it is swiping your card or automatically paying your Netflix and Spotify subscriptions.
While November’s CPI rose by 7.1%, implying a cooldown from the past couple of months, it still remains quite lofty. Due to inflation, combined with robust consumer spending amid low unemployment levels and society becoming increasingly cashless, it’s more than likely that both Visa and Mastercard will continue growing their revenues and profits in the double digits as we advance.
This tendency was reflected in Visa’s and Mastercard’s most recent results. In its most recent fiscal Q4 results, visa reported net revenues of $7.8 billion, implying year-over-year growth of 19% — 23% on a constant-currency basis. Of course, higher transaction volumes were a great contributor, as they rose 10% compared to last year. However, higher nominal prices on goods and services make a real difference, too. Mastercard’s most recent fiscal Q3 results also illustrated a similar trend, with net revenues landing at $5.8 billion, up 15%, or 23% on a constant-currency basis.
Inflation’s Effect on Profitability
But wait, there’s more! Besides inflation boosting Visa’s and MasterCard’s revenues, it can also help lift their margins higher. There are many companies out there whose revenues benefit from a highly-inflationary environment, but at the same time, their expenses increase at an equally-high rate. It makes sense, as they also have to pay more for materials, utilities, logistics, labor, and so on. However, Visa and Mastercard aren’t bugged by any of that. Their frictionless, lean business models largely incorporate no such costs. Thus, besides their existing infrastructure that facilitates electronic transactions and is regularly expanded, Visa and Mastercard record relatively limited operating expenses.
The combination of growing revenues against relatively stable expenses results in a constant expansion in margins, meaning that profits are set to keep growing even faster than revenues. For context regarding how insanely profitable Visa & Mastercard are, their gross margins essentially stand at 100%, as both companies record no incremental expenses for every transaction processed. Further, their EBITDA margins over the past twelve months stand at 70.3% for Visa and 60.5% for Mastercard. Net income margins for the same period stood at 50.6% and 45.2%, respectively.
There are no other companies at their scale that are this profitable, and high inflation levels should help these margins expand even further!
Is Visa Stock a Buy, According to Analysts?
Turning to Wall Street, Visa has a Strong Buy consensus rating based on 17 Buys, one Hold, and one Sell assigned in the past three months. At $250.44, the average Visa stock price target suggests 20.46% upside potential.
Is MA Stock a Buy, According to Analysts?
As far as Wall Street’s take on Mastercard goes, the stock has a Strong Buy consensus rating based on 20 Buys and one Hold assigned in the past three months. At $400.85, the average Mastercard stock price target suggests 15.8% upside potential.
Takeaway – Earnings Growth Likely Priced in Already
Growing revenues, expanding margins, and the underlying organic shift toward a cashless society should result in swift earnings growth for both Visa & Mastercard. Specifically, consensus estimates indicate that Visa and Mastercard are expected to grow their earnings-per-share figures at a compound annual growth rate of 16.5% and 21.1% over the next five years, respectively.
That said, it appears that Mr. Market has already priced in most of the upside potential. Visa’s and Mastercard’s current stock prices imply forward P/Es of 25.7x and 31.0x. While these multiples are rich, they do reflect analysts’ forward-looking earnings-per-share growth. Nevertheless, they should also imply little upside moving forward as both stocks will likely grow into their valuations in the coming years.
I wouldn’t expect these multiples to be sustained once (and if) these growth estimates materialize, especially with rates still on the rise.
