Visa has a Big Problem

The latest financial numbers indicate that Visa (NYSE: V) has a big problem. The payment processor’s net income took a big fall during second quarter 2016.

Visa reported a net income of $6.857 billion in March 2016; that fell to $5.572 billion in June 2016. That adds up to a drop of $1.285 billion in just one quarter.

The income drop was in spite of slow but steady revenue growth at the payment-card giant. Visa reported revenues of $14.06 billion in December 2015; that grew to $14.28 billion in March 2016 and $14.39 billion in June 2016.

Those numbers indicate that Visa’s revenue growth; and perhaps its business model, is not sustainable. Particularly disturbing is the sudden; and inexplicable income, drop which threatens the whole value investment argument for Visa. This company might not be the cash cow that some of us have assumed.

Is Visa Making Money?

What is truly fascinating is that Visa is still making a lot of money from its operations. The company reported a profit margin of 11.35% on June 30, 2016, ycharts data indicates.

That profit margin might be deceptive because Visa’s free cash flow has collapsed. Visa reported a free cash flow of $171 million on June 30, 2016. That was 1.682 billion less than December when Visa reported a free cash flow of $1.682 billion. It looks as if Visa has suffered a sudden drop in cash flow that might be catastrophic.

Evidence of this is provided by Visa’s cash from operations; which dropped by $1.808 billion during second quarter 2016. Visa reported $6.664 billion in cash from operations in March 2016, that fell to $4.856 billion in June.

The company has had sudden drop in cash flow that would prove disastrous; if it continues for another quarter. An early casualty of a bad third quarter at Visa; would be the $78.35 share stock price, reported on July 26, 2016, – which is beginning to look overvalued. My prediction is that Visa’s shares are in for a major fall and soon.

Why are Visa’s Income and Cash Flow Collapsing?

The important question we need to ask here: is why are Visa’s income and cash flow collapsing? My first guest would be Visa’s exposure to America’s brick and mortar retail sector; which is undergoing a serious disruption.

Visa is heavily reliant on retailers like Target (NYSE: TGT); which cater to a shrinking middle class clientele. Target’s revenue fell by $1.01 billion during the second quarter of 2016; dropping from $73.87 billion in January to $72.86 billion in April 2016. Sales at some other retailers are also flat; Walgreens (NASDAQ: WBA), reported second quarter non-pharmacy sales grew by just .1%.

That might mean Visa is vulnerable to Amazon (NASDAQ: AMZN) and online retail. The Everything Store’s revenues increased by $6.41 billion in first quarter 2016; rising from $107.01 billion in December to $113.42 billion in March 2016.

This thesis seems to be verified by PayPal’s (NASDAQ: PYPL); revenues which increased by $762 million during the first half of 2016. The digital-payment processor reported $9.248 billion in revenues in December 2015; that increased to $9.655 billion in March 2016 and $10.01 billion in June 2016.

Note: PayPal cannot be used to pay directly on Amazon; but the online-retail giant will take PayPal’s popular MasterCard. Despite that it looks as if PayPal is taking business from Visa, which is an interesting state of affairs.

Visa may have to drastically change its business model in the near future just to survive. Possible moves would be to offer a digital wallet of its own like MasterCard’s (NYSE: MA) Masterpass or Chase Pay, entering the online lending arena like American Express (NYSE: AXP), opening or buying a bank, or offering blockchain based solutions that take bitcoin.

Visa is Still a Good Investment

Oddly enough Visa is still a pretty good investment despite the income drop. The payment processor still has some great attributes including:

• Cash and short term investments of $8.752 billion on June 30, 2016.

 

• $9.264 billion in cash from financing on June 30, 2016.

 

• A profit margin of 11.35%

• A return on equity of 19.32% on July 23, 2016.

 

• A dividend yield of .68% on July 23, 2016.

 

• Total assets of $63.87 billion on June 30, 2016. Visa’s assets have grown significantly in recent months. They were worth $54.33 billion in March 2016, and $39.43 billion in June 2015.

 

All this gives Visa a lot of float; which makes it a great company. Although I would hold off buying it for now; because I think Visa’s share price will drop significantly in coming months. When the share price drops, Visa will become a tremendous value investment. Until then wait and see because big changes are coming at Visa and soon.