The U.S. consumer has been in a funk for several years now. European consumers feel even more pinched. Even the go-go economies of China and Brazil are seeing the signs of weakening consumer sentiment. Still, credit card giants Visa (NYSE: V) and MasterCard (NYSE: MA) have managed to whistle past the graveyard. They've seen their shares soar ever-higher, becoming a "must-own" stock for many mutual funds and hedge funds.
"We're not banks"
Perhaps the greatest attribute of these stocks is that they carry almost none of the risk other financial-service providers bring. They don't own stocks and bonds, they don't underwrite equity and fixed-income offerings, and they don't hold loans that might go into default. Visa and MasterCard simply take a slice of every financial transaction. And with the world slowly migrating to a "cash-free" environment, these companies have been able to boost sales at a 10%-plus annual clip during the past eight years. In fact, they've never had a down year in terms of revenue growth. And investors have responded in kind.
As the charts below show, these credit card issuers have been steadily rising in value, even as the broader market has gyrated up and down in the last six quarters.
These two firms now sport a collective $135 billion in market value, which is up more than 50% in the past year alone. Yet UBS Analyst John Williams spots trouble ahead. He says the troubled global economy is about to negatively affect credit-card transaction volumes, right at a time when these two firms' organic expansion plans have maxed out. "Investors are not prepared or positioned for a slowdown in the businesses," he says.
Part of his concern stems from U.S. consumer spending, which accounts for 52% of Visa's revenue and 38% of Visa's. Recent economic reports point to a fresh slowdown in consumer spending as we head toward the all-important back-to-school season. In the quarter ended March, Visa noted a 4% increase in year-over-year transaction volume growth. By May, that figure had slipped to 2%. Don't be surprised if it turns flat or negative this summer.
Payment-processing firm First Data, which tracks card usage on a monthly basis, recently noted that transaction volume growth slipped from May to June. "Stubbornly high unemployment and economic anxiety took a toll on sales as consumers pulled back on spending. Despite a sustained decline in fuel prices, consumers have not translated those savings into spending elsewhere," the company reported.
What are they worth?
To get a sense of how these stocks should be valued, you can look at their projected earnings growth rates and their current price-to-earnings ratios. Both stocks trade for around 16-17 times projected 2013 consensus EPS (earnings per share) estimates. (These forward multiples had been in the 10-12 range before the stocks took off during the last six quarters). Williams slightly lowered his 2013 EPS assumptions to the point that each of these stocks now trades for around 15 times his projected 2013 profits.
Trouble is, it's hard to square his very modest EPS reductions with his assessment that growth is set to slow sharply. But that's how Wall Street works. Analysts tend to trim forecasts only modestly at first, and then proceed to make cut after cut. A meta-analysis of this analyst's actions implies that he -- and his peers -- will likely start to steadily trim their profit view for these stocks.
On July 9, Williams gave a "sell" rating on these stocks, and his price targets represent only 5% downside. Yet price targets are irrelevant. Instead, investors trade on trends, and in this case, the trend looks to be off-putting. "We believe both companies' exposure to a slowing consumer-spending backdrop makes a slowdown in key metrics simply unavoidable." That's a reason to sell for any major institution that has been loading up on this stock. And it's that move to profit-taking that can take these stocks well below Williams' price targets of $113 for Visa and $403 for MasterCard.
The credit card penalty
I've been thinking about these stocks recently for an entirely different reason. In the past few weeks and months, a number of gas stations in my area have started to charge 10 cents more per gallon to use credit cards. As a result, I'm now paying for fill-ups with cash. I wonder how many other consumers are doing the same. I've also had a few other retailers offer me modest discounts if I pay in cash, as they too are balking at high credit-card fees. This kind of action is just now showing up in the broader card-usage data, as this The Wall Street Journal article describes. We may be hearing more and more about this in coming months.
Risks to Consider: As an upside risk, both of these firms are set to go to trial in September in response to charges that they conspired to raise fees for merchants in a collusive manner. Investors are currently anticipating $7 billion to $10 billion in damages and near-term caps on the fees they can charge, but a more favorable settlement could boost these stocks temporarily.
Action to Take --> It's a bit early to see these stocks as solid short candidates. They appear to have decent -- albeit not significant -- downside. In this vulnerable market, however, investors should see stocks such as these, which have posted major gains and appear to be at risk of falling EPS estimates, as great candidates for profit-taking.