The Investment Case for Visa & Mastercard
Originally published on Linkedin
Investing in individual stocks can be very risky to say the least. So if one ever chooses to do so, the person who takes it seriously as if it were a major lifetime decision is probably going to do a lot better than another who bought on impulse.
I recently invested some of my personal savings into Visa and Mastercard, which I have been analysing for the past few weeks. Ideally I would have spent more time before buying any shares and if it turns out that I made a mistake, I will probably attribute it to this.
6 reasons I invested in Visa & Mastercard
The global shift from physical cash to digital payments is almost inevitable, offering significant growth opportunities for Visa and Mastercard: According to the FIS Global Payments Report, $7.6 trillion or 16% of global consumer spending in 2022 was made in physical cash. We should note that this 16% figure refers to the total value of spending – not the total number of times cash was used for each transaction. If instead we look at how often cash is chosen as a payment method per transaction (regardless of the size), we can refer to a study by the European Central Bank (ECB): The ECB estimates that cash was used for 59% of consumer transactions in the Eurozone in 2022 (down from 79% in 2016). We can also consider that there are 13 countries where more than 40% of the population remains unbanked.
Visa and Mastercard dominate the global payments industry: According to the latest annual reports for both companies, Visa was involved in $14.1 trillion in payments while Mastercard grossed $8.2 trillion in volume. In 2020 Visa and Mastercard made up 40% and 24% of the global card payments industry respectively. 32% of worldwide market share went to the Chinese state-owned company, Unionpay. This is because Mastercard and Visa's ability to operate in China is heavily restricted by protectionist policies, which have enabled Unionpay to take up 99% of China's card payments market. However Unionpay's market share outside of China is estimated to be just 1%. If instead we look at market share in Europe, Visa has 60% and Mastercard has 39%. In the US, Visa has 59% and Mastercard has 26%.
Both companies benefit from the 'network effect': This is a phenomenon whereby the more people use a product or service, the more valuable it becomes. The more cardholders use Visa and Mastercard, the more merchants are likely to accept them as payment methods, and vice versa. The network effect creates substantial barriers to entry for potential competitors - any new entrant would need to convince both consumers and merchants to adopt a new payment network. Moreover, the established networks of Visa and Mastercard have gained regulatory approvals and developed robust security measures over the years. This adds to their credibility and makes it harder for new entrants to replicate the level of trust and security that the existing networks offer.
Visa and Mastercard work with their fintech competitors: The payments industry is a highly competitive environment. However in many cases, Visa and Mastercard are able to convert their threats into opportunities by providing services and infrastructure to the fintech space. For instance, the image of this article includes my Revolut and Monzo cards. You will also find Visa and Mastercard's logos on debit cards issued by Paypal, Wise, Crypto.com, Coinbase, Square, N26 and many more. Then if you consider the rise of digital wallets, Visa and Mastercard are major partners with Google Pay and Applepay. When Chinese tourists spend money abroad, Alipay's collaboration with Visa and Mastercard enables them to do so efficiently.
Visa and Mastercard's business models are inflation-resistant: Since payment processors mostly charge in percentages, a big part of their revenues will rise in lockstep with consumer prices. Moreover, Visa and Mastercard are extremely high margin businesses. This means that even if their expenses rise faster than their revenues, the impact on profitability would be small compared to how such an outcome would damage a low margin business. To illustrate my point: Company A makes things for £5 and sells them for £10, whereas Company B makes things for £9 and sells them for £10. If inflation causes costs to rise by 10%, Company A would now make things for £5.50 and sell them for £10, however Company B would be making things for £9.90 and selling them for £10. So Company A’s profit margin takes a 10% hit while Company B’s margin gets slashed by 90%. Company B would be forced to raise prices while Company A has a lot more breathing room. To conclude, high profit margins + revenues linked to spending levels = inflation mitigation.
Visa and Mastercard's economic numbers are phenomenal:
66% operating profit margin for Visa and 55% for Mastercard (four-year average).
51% net profit margin for Visa and 45% for Mastercard (four-year average).
50% per annum return on capital employed for Mastercard and 21% per annum for Visa (11-year average).*
*Return on capital employed (ROCE) measures how much operating profit VISA and Mastercard make in relation to their total long-term debt and shareholder equity – in other words, how efficient they are with shareholder’s money and the cash they borrow.
How do these numbers compare to the market?
The S&P 500, which consists of the 500 largest US-listed companies, is widely considered to be the best index to invest in. Based on data from csimarket.com, the S&P 500’s average operating margin is 17% and its net profit margin is 11%. According to various annual letters from Fundsmith Equity, the S&P 500's average return on capital employed is often around 15%-18% per year.
Visa vs Mastercard - why invest in both?
The simple answer: Since both companies have somewhat of a duopoly in global payments, owning both can serve as a hedge.
However after looking at the fundamentals of both businesses, I was originally going to write an article solely on the investment case for Visa. It has more market share and higher profit margins than its main competitor. Furthermore, Visa's long term debt represents only 57% of its shareholders' equity while Mastercard's debt-to-equity ratio is at an unsettling 219%. In a rising interest rate environment especially, high debt levels become increasingly risky.
Another reason I preferred Visa it that its valuation looked more attractive. It was trading at a price-to-earnings (P/E) ratio of 30x, which still isn't cheap, while Mastercard was at 37x. The higher the P/E, the more expensive and vice versa.
But what changed my mind about Mastercard is its incredible growth rate. Over the past 11 years, Mastercard's return on capital employed (ROCE) has averaged 50% per annum. To put this into perspective, Visa's ROCE of 21% per year is still considered high.
So while Visa looks like a relatively safer bet, if Mastercard can continue on its current trajectory then the risks would more than pay off.
In light of their differing risk profiles, I chose to allocate my recent investment one third into Mastercard and two thirds into Visa. If I had to invest in only one company, I would pick Visa.
Business Risks for Visa and Mastercard
When you look at Visa's 51% net profit margin or Mastercard's 50% return on capital, these numbers are far too impressive and attractive for people to ignore. You could argue that something has to give:
Regulation is considered to be the main threat to Visa and Mastercard. Because of their sheer size, they face many challenges and a lot of scrutiny from governments/regulators around the world, whether it is having their fees capped or being accused of anti-competitive practises. On the other hand, heavy regulation can often entrench the positions of big businesses by making it costly to compete in the industry.
Competition: While Visa and Mastercard have done well so far in working with their competitors, we cannot be sure that this will always be the case. It could be that enabling others is beneficial in the short term but in the long run it could end up creating larger competitors. Moreover, if new technologies are disruptive enough, they may transform the payments industry too rapidly for Visa and Mastercard to keep up with. My optimistic side says that their partnerships will continue to be win-win and any new technologies will be successfully adopted by Visa and Mastercard, serving to maintain or increase profitability.
Disclaimer
I hope you enjoyed reading this and found it insightful. However this article is not an investment recommendation and does not constitute financial advice. I essentially wrote it for myself in order to justify some personal decisions I made, which are very high risk compared to buying diversified funds. I do not encourage anyone to buy individual stocks and if they do they should put in a serious amount of work and take full responsibility.
While Visa and Mastercard look exceptional in the rear-view mirror, past performance is no guarantee of future performance.