The Massive Growth Potential of Brazilian Credit Cards

Among the emerging markets, Brazil has one of the most technologically advanced credit card industries. Compared to developed nations like the United States, however, this industry of Brazil is still in the very early chapters of its growth story. Imagine if it were possible to travel back in time and invest in Visa's (V -1.57%) U.S. operations about two decades ago, back before e-commerce was mainstream. That's the type of growth opportunity Brazil's credit card industry presents investors today.

Source: Nicolas Raymond.

As a percentage of personal consumption expenditure (PCE), Brazilian card payments in 2011 were only 26.7%, or about the same percent the United States had back in 1998. In 2011, the U.S. came in at 48.1% of PCE. In 2010, the number of transactions per card in Brazil were just 11.2 compared to the United States' 58.6 transactions per card. Needless to say, Brazil still has a long way to go to reach the level of U.S. credit card use.

The Visa of Brazil
The largest payment system company in Brazil by revenue -- USD $2.5 billion in 2012, up 28% from 2011 -- Cielo (CIOXY 5.02%) is essentially the Visa of Brazil. Formally called VisaNet, Cielo was formed as a joint venture between Visa and three major Brazilian banks back in 1995. The company was responsible for processing every Visa credit and debit card transaction in Brazil.

That was until July 2010, when new bank regulations introduced multi-brand rules for the country. Now other Brazilian payment system companies are allowed to process Visa card transactions, and Cielo is allowed to process brands previously exclusive to other companies. Today, Cielo is a processor of multiple international, regional, and local private label card brands.

Much like Visa, Cielo is not actually a financial company. Cielo does not issue any credit cards, extend any lines of credit, or collect on any debts. All of that is the responsibility of the issuing banks. Cielo is simply a technology company responsible for connecting customers, business, and banks together through its electronic payment network. Once that network is in place -- currently present in 99% of Brazilian municipalities -- there is actually very little capital expenditure requirements.

Cielo simply collects a fee for each transaction that occurs over its network (5.3 billion individual transactions in 2012). This makes Cielo a very low-risk, high cash generating business. This is why Cielo is able to implement an extremely shareholder-friendly policy of paying at least 50% of the company's net profit as a dividend.

The American Express of Brazil
Owned by the largest financial institution in Latin America, Itau Unibanco's (ITUB -0.72%) Redecard is the second largest payment system in Brazil.

Redecard is very similar to Cielo in nearly all respects. Redecard is available throughout the majority of Brazil, has low capital expenditure requirements, and generates a ton of cash. Like Cielo before the 2010 regulatory changes, Redecard was the exclusive payment system provider for every MasterCard and Diners Club card transaction in Brazil. Today, the multi-brand Redecard now adds Visa and others to its very large portfolio of card brands.

Also under the Itau Unibanco corporate umbrella is another payment system called Hipercard, the third largest payment system in Brazil. In 2012, Redecard and Hipercard together processed over 3.3 billion credit and debit card transactions and totaled over USD $1.77 billion in revenue for Itau Unibanco's card transaction division.

Hipercard is very different from Cielo and Redecard in one important aspect, though. Hipercard began its life as a supermarket loyalty card in the 1970s, and then a supermarket store card with its own revolving line of credit in the 1980s. But slowly, over the years, it transformed itself into its own independent credit card company akin to American Express.

In addition to operating its own payment network, Hipercard is also a bank that issues its own brand of cards and loans its own money, following the American Express business model. Today, Hipercard is a nationwide credit card brand with over 13.5 million cards accepted at establishments all throughout Brazil.

Foolish bottom line
Although Brazil's economy and stock market have had a particularly tough 2011, 2012, and 2013, the country still has many attractive investment opportunities for those able to find them.

Through the worst of it, the businesses of Cielo and Redecard continued to produce record earnings. Likewise, Cielo's stock continues to make new all-time highs in 2013, while the Redecard acquisition resulted in Brazil's largest corporate takeover in 2012. With nearly 200 million Brazilians and an inevitable secular shift away from cash payments toward electronic transactions, not even a bad economic environment can stop these companies.