Visa Inc. (V, Financial) runs an extremely profitable data network and takes a small cut in over 213 billion payment transactions each year (a 2023 figure).
In effect, the company is a huge cash cow generator since it does not need to spend huge capital expenditure dollars to keep its network running efficiently. Its free cash flow margins are now approaching 58%.
As a result, the stock looks deeply undervalued here. It could easily be worth 25% more than its price of $275.16 as of the time of writing.
Consistent growth drivers
Visa reported excellent fiscal second-quarter results on April 23 for the quarter ending March 31, 2024. Net revenue rose 10% year over year and its diluted non-GAAP earnings per share increased 20%.
The key drivers for its growth were low expenses, low capital expenditure requirements and continued growth in underlying transactions and payment volume.
For example, Visa's quarterly deck showed that most of its key business drivers were up double digits.
This is a consistent theme with Visa. It has essentially led to massive profitability, especially on a free cash flow basis.
Free cash flow is the cash a company generates after all its cash expenses, plus all capex spending and net changes in working capital needs. Since Visa has little inventory and its capex needs are small, it produces a huge amount of FCF.
FCF margins and growth
For example, in the last year, Visa generated between $3.30 billion and $6.60 billion in free cash flow. This was on huge FCF margins, which have ranged between 38% and 77%, as seen in the table below.
The table above shows that over the last year, Visa made an average 58% FCF margin. This means that almost 60% of all its revenue goes straight into the company's bank account with no remaining obligations or costs.
That is the definition in today's world of a cash cow.
For example, in the latest quarter ending March 31, its FCF margin was 48.80%, or almost half of sales becoming FCF. That was up from 38.50% in the prior quarter. This is because payment volumes and transactions are seasonal. So it's best to look at the trailing 12-month FCF margins. This can be seen in the table below.
The table shows that over the last four quarters, using the trailing 12-month periods (i.e., an annual look-back at its results each quarter), its FCF margins have been very stable.
For example, the FCF margin has ranged between 58.60% in the past four quarterly trailing 12-month periods to 57.80% in the latest trailing 12-month period. This irons out the seasonal effects of payment transaction peaks.
In fact, the table below shows that over the past three years, the free cash flow margin has actually been above 60%. This helps us project out future FCF estimates.
Based on analysts' revenue estimates, I expect Visa will make at least 58.40% FCF margins this year (ending in September) and next year.
This is because the company has very consistently low capex requirements. This can be seen in the table below.
This shows that, on average, Visa's operating cash flow margins have been 61.80% in the past several quarters. Moreover, its capex spending has averaged about 3.40% of sales.
As a result, I project that its FCF will be $20.90 billion for the fiscal year ending Sept. 30. That works out to a 54.80% FCF margin. The same applies to 2025 estimates and both are based on analysts' estimates that revenue will rise by 4.90% in fiscal year 2024 (i.e., $35.80 billion) and by over 10% in 2025.
In effect, Visa's free cash flow will be up by 17.30% in the next two years, rising from $19.70 billion in 2023 to $23.10 billion by 2025. That represents a compound growth rate of 8.30% annually over the next two years alone.
This has good implications for the stock price going forward.
Valuing the stock using FCF yield
One very useful way to value a stock, especially one that pays a dividend like Visa, is to assume it might pay out 100% of its FCF as a dividend. That is how an FCF yield valuation metric works.
For example, in Visa's case, it spends only about 19% to 20% of its free cash flow on dividends. In the last year, its dividend cost was $3.99 billion and FCF was $19.73 billion, so the ratio was 20.20%.
However, much of the rest of the FCF was spent on buybacks. That implies the ratio will be lower since $3.99 billion divided by my estimate of $20.9 billion in FCF this year works out to 19%.
The point is that a very low amount of its FCF is spent on dividends. Today the dividend yield is 0.76% ($2.08 dividend per share/$276.16 price).
But what would the yield be if 100% of the $20.8 billion were to be paid out to shareholders?
First, note that in the last year, Visa has spent over $13.10 billion on buybacks, as seen in the table below. That represents 2.36% of its $557 billion market cap.
That means its shareholder yield (dividends plus buybacks divided by market value) is slightly over 3%. The dividend yield of 0.76% and the buyback yield of 2.36% equals a shareholder yield of 3.07%.
In other words, the total $17.10 billion it spent on buybacks and dividends represents 3.07% of its $557.20 billion market cap.
So let's use this 3% figure to answer the question of what the dividend yield would be for the stock if it paid out 100% of its FCF as a dividend.
Here is how that works out. Look at the table below. It shows that the market cap would be $734 billion on average over the next two years using a 3% FCF yield metric.
That is because dividing the FCF estimates by 3% is the same as multiplying these forecasts by 33.33. The net result is the average price target is $362.34 per share. That represents an upside of 31.70% over today's price of $275.16.
However, just to be conservative, let's assume the market gives it a higher yield of 3.33%, or a market multiple of just 30 times.
This shows the average price target is $326.11 per share, an upside of just 18.50%.
So, on average, the net result is we can expect the market will value the stock at $344.22 per share, or an upside of 25% from here.
However, that does not take into account the long-term effect of Visa's massive share buybacks. It implies that over the long run, these could have a significant effect on the stock price.
Buybacks could juice the share price significantly
The table below shows that over the past two years, the company's outstanding shares have been consistently declining. The year-over-year decline in common stock shares (on an “as converted” basis) has been about 2.50% every quarter on a trailing 12-month look-back basis.
This is due to the company's massive usage of FCF of buybacks to reduce its net shares outstanding. I pointed out above that $13.10 billion of its $17.10 billion in last 12 months FCF was spent on share repurchases, or about 76.60%.
The net result is that the buyback yield of 2.36% has led to a consistent 2.50% annual drop in the number of shares outstanding.
That has huge implications, given the marvels of compounding, of what to expect for the stock. For example, look at the table below of how this could compound over the next five, 10 and 15 years.
It shows that when using a 2.50% annual drop in shares, the total decline could be as much as 28% in 10 years and almost 45% in 15 years.
Moreover, as the table below shows, just a slight increase to 2.75% over 15 years can lead to a 50% drop in the total shares outstanding.
This implies that Visa stock could be worth significantly more over the next decade just based on its massive buybacks. The net result is that investors are likely to get a good return on the company's large share buyback purchases.
The key is sticking around with Visa for the long term. And why not? It is a veritable cash cow with massive FCF margins and huge shareholder return payments.
