Janney Ups Visa, MasterCard To Buy After Selloff

It's been a good week for Visa (V) and MasterCard (MA)—two days in and they've enjoyed two rounds of upgrades.

Today, the bullishness comes from Janney Montgomery Scott's Thomas McCrohan and Leonard DeProspo, who boosted their ratings on both names to Buy.

For Visa, the upgrade came with a target price increase from $210 to $240 and they write that the recent selloff in the name provides an attractive entry point "to own one of the better business models in payments." They count the company's powerful network, worldwide brand, and its role in influencing payment standards among its core strengths, and note that the increase of mobile payments has also served to increase the number of places where Visa is accepted.

They write that strong margin expansion in the past year and a half means that mid-to-high teens earnings per share growth is possible even if margins contract this quarter and next, as the company's guidance suggests.

More thoughts below:

Changes to FANF fees beginning April 1, 2015. Last week, Visa modified its FANF pricing (Fixed Acquirer Network Fee) to include a 15 bps volume-based charge for sub-merchants of payment aggregators. Previously, payment aggregators only paid one lump sum payment of $40,000 per month, which created a cost advantage for aggregators versus traditional acquirers and ISOs that were required to pay a separate FANF fee per merchant location. The new FANF pricing is 15 bps of monthly volume, which translates into $30 million of incremental high-margin fee income for Visa based on $20 billion of aggregator volume.

Fiscal 2014 EPS guidance achievable. First quarter margins of 65.8% were a record, and were 230 bps above the previous record (FQ1-2012). FY 2014 EPS guidance calls for mid-to-high teen growth but assumes higher operating expense in 2Q and 3Q and ongoing F/X headwinds from current turmoil in emerging markets. Mid-to-high teen EPS growth appears reasonable given the 3-year average growth of 25.5%. Our FY 2014 margin estimate is 63%, resulting in 16% EPS growth.

Litigation risks moderating. The recent appeal court hearing greatly reduces the risk of further changes to debit card network routing, and Walmart's (WMT) recent appeal to the anti-trust settlement was moved from Arkansas to Brooklyn. Based on prior rulings, the courts in Brooklyn will likely be more sympathetic to Visa than to Walmart.

Lack of any credible disruptive threats. Disruption remains a consistent theme, but the majority of advances we have witnessed so far are occurring on the edges of the network as opposed to the payment network itself.

As for MasterCard, McCrohan and DeProspo have an $81 price target on the stock, up $3. Again, their reasoning is the same, as they see the pullback in the stock as a good entry point, and believe it shares the same core strengths as Visa.

More details:

Recent deal with Sam's Club continues co-brand momentum. MasterCard recently won the Sam's Club co-branded credit card portfolio in a competitive take-away from Discover (DFS). When we met with management of MasterCard in December 2013, the CEO indicated that MA was winning 60% of the co-brand deals out for bid (e.g. Bass Pro Shops, Hawaiian Airlines, Virgin America). Sam's Club is one of the three leading membership-based warehouse clubs in the United States. Recent regulatory filings disclosed that Sam's Club accounts for 12% of total Wal-Mart revenue, which equates to $57 billion in total revenue.

Co-brand momentum gives us confidence fiscal 2014 revenue guidance achievable. The company provides 3-year financial targets as opposed to annual guidance, but for 2014, management has indicated they expect net revenue growth at the low-end of its 3-year target range of 11%-14%. Our 2014 revenue growth estimate of 12.9% is above street expectations of 11.5%.

Litigation risks moderating. The recent appeal court hearing greatly reduces the risk of further changes to debit card network routing, and Walmart's appeal to the recent anti-trust settlement was moved from Arkansas to Brooklyn. Based on prior rulings, the courts in Brooklyn will likely be more sympathetic to Visa than Walmart.

Lack of any credible disruptive threats. Disruption remains a consistent theme, but the majority of advances we have witnessed so far are occurring on the edges of the network as opposed to the payment network itself.