Purse Strings Are Loosening... That's Good News for This Electronic-Payments Leader

Consumer spending powers the U.S. economy...

Americans are continually called upon to purchase goods and services in ever-increasing amounts. In 2019, consumer spending made up 70% of U.S. gross domestic product ("GDP"). A lot of this came from credit and debit cards.

But during the pandemic, consumer spending dropped off a cliff...

People were stuck at home and focused on staying safe from the coronavirus. Many retail shops had to temporarily close down. Spending was focused on "essential" items like food, household cleaners, and home-entertainment products (like video games). As a result, non-essential spending like for travel, apparel, and automobiles tumbled.

Now, things are beginning to return to normal. Lockdowns are being lifted. Stores are starting to reopen. Consumers are beginning to spend their cash more freely again. And that's a good sign for today's company...

Visa (NYSE: V) is the world's leader in digital payments. Its electronic-payments network is the largest in the world by payment volume and in terms of the number of merchants that accept its cards.

Its business model is simple...

Let's say you walk into a coffee shop. You buy two coffees and a bagel for $10 and pay with your Visa credit card.

The card-issuing bank receives an interchange fee, which is by far the largest portion of the overall transaction fee. The interchange fee varies based on a number of factors, like whether it's a rewards or non-rewards credit card, or whether you swiped your card at a point-of-sale ("POS") device or bought something online.

The interchange fee for a credit transaction typically ranges from 1.2% to 2.4% of the purchase price, plus a small flat fee. (Interchange fees on debit cards are usually far lower than those on credit cards.)

There's also the assessment fee (sometimes called the "card association fees"), which goes to the network operator, such as Visa or Mastercard.

Assessment fees are a fraction of the size of interchange fees. For example, Visa's assessment fee is just 0.14% on many credit transactions. For your $10 coffee shop purchase, that would be less than $0.02.

However, a huge amount of money is spent across all the cards on the Visa network. So these tiny fees add up... quickly.

Total payments volume (credit and debit purchases) on the Visa network was $8.9 trillion in the calendar year 2019. (Visa's fiscal year ends in September.) Visa's payments volume is almost twice that of Mastercard (MA). It holds about 60% of the credit and debit card market share, while Mastercard holds about 30%.

At the end of 2019, there were 345 million Visa cards in the U.S. and about 800 million Visa cards outside of the U.S.

That's a lot of cards in circulation. If you consider that Visa collects a small fee every time one of these cards is swiped, that means a lot of revenue for the company.

Visa's business can give us a great read on what's going on in the broader economy. As we mentioned above, consumer spending plummeted during the pandemic. Throughout the end of March and April, the company said it noted a "significant deterioration" in consumer spending.

But things are turning around...

In a filing with the U.S. Securities and Exchange Commission ("SEC"), Visa said U.S. payments volume fell 5% in May compared with the same month last year. That's a sharp increase from the 18% decline the company saw in April. And by the end of May, Visa said spending was flat on a year-over-year basis.

Not only is spending recovering, but Visa is seeing increased adoption of card usage because of the pandemic...

In an interview with the Financial Times, Charlotte Hogg, the head of Visa's European business, said the company has seen a sharp increase in online purchases as well as other digital payments because of the pandemic.

Hogg also said there has been a steep decline in physical cash transactions. "Behaviors have fundamentally changed," she told the FT. Consumers are reluctant to use physical cash – it carries germs and means physical interaction with the cashier.

As consumer spending recovers, most of it will be done digitally, according to Hogg. And as the leader in digital payments, Visa is perfectly positioned to benefit as people shift away from using physical cash.

The consumer recovery has spurred a 39% rally in Visa shares from their March low. And the stock could go even higher from here.

As consumer spending rebounds to pre-pandemic levels, and possibly even higher than that, Visa will reap the benefits. And this trend should be a continued tailwind for Visa shares.

Sometimes investing is simple.