Visa Inc. (NYSE:V) could be slightly undervalued, but there are likely better opportunities

This article first appeared on Simply Wall St News.

After a sharp decline until the fourth quarter of 2021, Visa Inc.. (NYSE: V) has rebounded from the lows, but appears to be struggling to maintain momentum.

So far, the outlook looks mixed between recent ratings downgrades and the resolution with Amazon over UK card payments.

Discover our latest analysis for Visa

Two downgrades and a resolution

Visa is moving to the cloud. The company just announced Visa Acceptance Cloud (VAC), which moves processing software from hardware devices to universal access in the clouds. The service is currently online on 6 sites. VAC aims to turn almost any device into a cloud-connected payment terminal, making payment service much more accessible and affordable for independent businesses.

During this time, Visa received 2 downgrades. First, Mizuho Securities downgraded from Buy to Neutral. At Mizuho, ​​they see the competitive risks of buy-now-pay-later competition and the impacts of COVID-19 on the cash-to-card track. The price target has been reduced from US$255 to US$220.

The second downgrade came from BNP Paribas Exane, which surveyed the spending habits of 3,000 consumers and found high cash usage in the UK, as well as in large EU markets such as Germany or France. BNP now classifies Visa as neutral, with a price target of $210.

After weeks of uncertainty, Amazon (NASDAQ: AMZN) and Visa have finally found a solution to the dispute that threatened to stop payments with UK-issued Visa credit cards. With almost 90% of Britons shopping on Amazon, the estimated lost sales due to the abandonment of Visa as a payment would have been nearly £1.4billion. Although we do not know the details, it is certain that without this agreement, both parties would end up losing.

Estimation of the intrinsic value of Visa

We generally believe that the value of a business is the present value of all the cash it will generate in the future. However, a discounted cash flow (DCF) model that we use is only one valuation measure among many, and it is not without flaws. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St analysis template.

We will use a two-stage DCF model which, as the name suggests, considers two stages of growth. The first stage is usually a period of higher growth, heading towards the terminal value, captured in the second period of “sustained growth”. First, we need to estimate the cash flows for the next ten years.

Where possible, we use analyst estimates, but where these are not available, we extrapolate previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow earlier than in subsequent years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, we therefore discount the value of these future cash flows to their estimated value in today’s dollars:

10-Year Free Cash Flow (FCF) Forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leveraged FCF ($, millions) $16.2 billion $17.9 billion $19.6 billion $22.4 billion $24.2 billion $25.6 billion $26.8 billion $27.8 billion $28.7 billion $29.6 billion
Growth rate estimate Source Analyst x9 Analyst x9 Analyst x5 Analyst x2 Analyst x1 Is at 5.74% Is at 4.6% Is at 3.81% Is at 3.26% Is at 2.87%
Present value (millions of dollars) discounted at 6.6% $15,200 $15,800 $16,200 $17,300 $17,600 $17,500 $17,200 $16,700 $16,200 $15,700

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $165 billion

We now need to calculate the Terminal Value, which accounts for all future cash flows after this ten-year period. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. Similarly, as with the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 6.6%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$30 billion × (1 + 2.0%) ÷ (6.6%–2.0%) = US$655 billion

Present value of terminal value (PVTV)= TV / (1 + r)ten= $655 billion ÷ (1 + 6.6%)ten= $347 billion

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$512 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of US$215, the company seems on the fair value at a 12% discount to the current share price. Ratings are imprecise instruments, however, keep this in mind.

NYSE: V Discounted Cash Flow January 17, 2022

The hypotheses

Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. The DCF does not take into account the possible cyclicality of an industry or its future capital needs, so it does not give a complete picture of a company’s potential performance.

Since we consider Visa as potential shareholders, the cost of equity is used as the discount rate rather than the cost of capital (or weighted average cost of capital, WACC), which takes debt into account. We used 6.6% in this calculation, which is based on a leveraged beta of 1.051. Beta is a measure of a stock’s volatility relative to the market as a whole.

Next steps:

Remember that the DCF model is not a perfect stock valuation tool. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued.

Although our intrinsic value is above the current price and the price targets mentioned in recent ratings downgrades, it is still not by a significant margin. While 11.6% might not motivate you enough to buy the stock, you might have additional interest in Visa — or maybe even own the stock.

In this case, we have compiled three essential elements you should examine in more detail:

  1. Financial health: Is there a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors such as leverage and risk.
  2. Future earnings: How does V’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
  3. Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation daily for every US stock, so if you want to find the intrinsic value of any other stock, just search here.

Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position at any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials.

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