Merchant processing firms such as Global Payments (NYSE:GPN) run relatively simple businesses - a customer swipes a card at a store, Global Payments sees that the money goes where it needs to between the banks, and it takes its cut. While there's ample competition to sign up (and retain) merchants and data breaches are an ever-present threat, these can be very profitable businesses with good returns on capital. In the case of Global Payments in particular, this not only looks like a profitable, growing business, but it's also one with an undemanding valuation and good global growth prospects.

Introduction To Dividends: Investing in dividend-paying stocks can be an effective method of building long-term wealth.

Solid Second Quarter Results
Global Payments did a good job in its fiscal second quarter of 2012. Revenue rose 11% and was modestly higher than analysts had expected. Revenue in the United States (the company's largest revenue generator) rose 16%, while revenue in Europe rose 14%. Canada was down 6%, while Asia-Pacific was up 1%.

On the margin side, the company saw some gross margin compression, but operating income rose 21% on a reported basis (and about 5% on an adjusted basis). On the reported number, operating margin improved about 160 basis points, comfortably ahead of analyst expectations. While profitably was a little less impressive in North America (operating income down 5% against 11% revenue growth), the international business did quite well (an operating margin of about 32%, with 21% growth on 11% revenue growth).

A Slightly Deeper Dive
While Heartland Payment Systems (NYSE:HPY) has been fairly aggressive with prices in the post-Durbin world, Global Payments seems to be doing fine anyway. Transactions were up 13% this quarter, suggesting that the company continues to do well with its share and business mix.

I was also a little surprised to see the strong European results continue. Apparently, results were quite strong in Russia, and even Spain saw transaction growth. On the other hand, the company mentioned weak macro conditions as the principal source of the weakness in Asia. In Canada, the company continues to see the impact of spread compression (transactions were up 4% in the quarter), but the company is close to the point where it will anniversary those changes and reported results should start looking better.

Plenty Left to Do Overseas
Global Payments is a pretty small player in the United States. While it's a more significant player in the small merchant space that it targets, its overall share is only about 4%. That's more than respectable against the likes of Wells Fargo (NYSE:WFC) (4% share), Heartland (about 2.5% share) and Total System Services (NYSE:TSS) (also about 2.5%), but I'm a little concerned about the potential for more competition from the likes of Square in the small merchant category. While Global Payments could arguably look to move up-market, that comes at the cost of smaller spreads.

I do believe, however, that there is ample overseas growth potential. Global Payments operates in a "triopoly" in the United Kingdom with WorldPay and Barclays (NYSE:BCS) and is part of a joint venture that is the largest processor in Spain. The company also has an important foothold in Russia, and I believe the company could do more deals in Europe to build the business. Asia could be an even bigger long-term opportunity. The company chose to pony up for the rest of its joint venture with HSBC Bank Canada (NYSE:HBC), and credit/bank cards are still an emerging payment option in much of Asia today.

The Bottom Line
I get a little paranoid when I see a well-known and well-followed company trading too cheaply, but that would seem to be the case for Global Payments. I believe the company can continue to grow revenue at a mid-to-high single-digit rate, and I see no reason why the company cannot generate average free cash flow margins in the mid-teens.

That said, I don't expect this to be a necessarily smooth ride. Like Heartland, Global Payments has experienced an expensive and embarrassing data security breach (though Global Payments' was smaller), and there's no guarantee that it won't happen again. What's more, this company has had a somewhat erratic history with respect to margins and free cash flow, and that adds to the risk.

I do believe the company is undervalued on the basis of free cash flow, and fair value could be in the $60 range. Accordingly, that makes it a worthwhile stock to consider at today's prices.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Budgeting

    5 Alternatives to Traditional Health Insurance

    Discover five of the most popular alternatives to traditional health insurance plans, alternatives that are increasingly popular as health insurance costs rise.
  2. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  3. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  4. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  5. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  6. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  7. Stock Analysis

    Tech Stocks Vs. Financial Stocks in 2016

    Consider the arguments for allocating more of your investment portfolio to either the technology sector or the financial sector for 2016.
  8. Stock Analysis

    The Top 5 Financial Penny Stocks for 2016 (CPSS, ASRV)

    Learn about some of the most promising penny stocks in the financial services sector that investors can consider adding to their portfolio for 2016.
  9. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  10. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
RELATED FAQS
  1. How can insurance companies find out about DUIs and DWIs?

    An insurance company can find out about driving under the influence (DUI) or driving while intoxicated (DWI) charges against ... Read Full Answer >>
  2. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  3. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  4. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  5. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  6. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center