Throughout the economic history of the United States, every recession has brought on a typical interest rate cycle caused by dire economic circumstances, followed by increased inflation and asset bubbles due to the low interest rate environment. Apart from macroeconomics, microeconomics, namely people, also share similar behavioral patterns in the consumer sector, including ensuing credit availability, balances, and usage.
The most recent period of low interest rates, from 2020 to early 2022, was brought on by yet another dire circumstance in the economy, creating inflationary environments and asset bubbles in areas such as cryptocurrencies, real estate, and stocks of all sectors. History does not repeat itself, but it does rhyme, and what does repeat itself is human behavior.
This time, people acted the same way they always tended to. In 2022, concerns about inflation arose, and FED chairman Jerome Powell was responsible for raising interest rates to combat this high economic indicator.
Ballooning Credit Card Balances
As the cost of living rises to levels near unbearable for some, and for others, high enough to cut down on some expenses and think twice about purchases. What the affected American consumer has in common is the solution to this issue.
Inflation, one of the leading economic indicators reported and widely watched by investors and economists, naturally took the spotlight.
However, some may have missed the rapid rise in United States credit card balances, which increased from just $800 billion in 2021 to a high of $986 billion, as reported in the fourth quarter of 2022. Current dynamics suggest further elevated prices and unaffordable everyday expenses for most consumers, leading to forecasts expecting an even larger balance in the first quarter of the 2023 report.
Markets will soon discover that this issue, which seemed to concentrate in the United States, also affects other leading economies worldwide. While the United States did lead the increases in credit card balances, the World Bank reports that Japan and China closely followed, with such increases being in the top three countries in the credit card balance index.
How can investors be sure that all of these balances are heading toward everyday items or discretionary purchases?
Easy. The International Monetary Fund has released a report dated December 2022 that breaks down credit card usage per category and increased balances throughout the year. This report shows that most (60%+) credit card transactions were consumer discretionary-related.
Visa Inc. at the Center of the Money Movement
Visa Inc. (NYSE: V) new CEO Alfred F. Kelly Jr. stated in the first quarter 2023 report that he is confident that Visa will reach new heights and remain at the center of the money movement. The reopening of the global economy throughout 2022 and the ensuing growth in overall credit card balances as a byproduct of increased payment processing and transaction volume activity was music to the company's ears.
Visa saw annual revenue growth of 21.6% in 2022 and an overall increase of 42.2% on a pre- and post-pandemic comparison basis. Revenue drivers mainly increased transactions overseas as international travel returned to a more normalized level. Most of the volume came from the credit rather than the debit segment.
This diversification of revenues from overseas markets and jurisdictions brought real operational benefits to the company's bottom line. The payment processing giant saw its lowest effective tax rate in a five-year lookback period, with 18.8% being the lowest recorded rate in 2019. In 2022, the company broke that record with a fantastic 17.5% rate. Increased savings and record volume increases allowed Visa to retain 51% of its revenues in 2022.
Visa management is not the type to collect a bonus for exceptional results and call it a year. Indeed, the company pushed to repurchase $4 billion of stock and pay out $12.8 billion in dividends to shareholders. The combined return effects from the dividend yield of 0.7% and share buybacks decreasing the total shares outstanding by 2% pushed the Visa stock price to rise to a price-to-earnings ratio of over 30x. Despite elevated multiples, the passed-down benefits of a highly profitable business may be worth the premium.
This company has a significantly steady return on invested capital (ROIC) metric. The pre-pandemic ROIC stood at 23.5%, dipped to 21% during the peak pandemic months, and is now back to 25.8% in 2022. This matters for investors because it is a proxy for the return they can expect via appreciation, dividends or buybacks on their shares.
Warren Buffett has quoted one of the greatest lessons from his friend and business partner Charlie Munger: "It is far better to buy wonderful businesses at fair prices than to buy fair businesses at wonderful prices." The balance sheet cannot reflect Visa's brand name, intangible value and reputation. However, its rock-steady business model, income generation for its stakeholders and other factors still allow analysts to see a 17.6% upside at these multiples.