FIS - Fidelity National Information Services Could Miss Earnings Potential Buy On Dip

Summary

• Fidelity National's revisions are very negative, with 18/19 EPS revisions being negative and 19/21 revenue revisions being negative.
• FIS's revenue base is secured by the stability of the bank technology business, which is ripe with long-term contracts and rich in recurring revenue.
• The company's operating profits are very promising, and reinvestment is largely unnecessary. FIS should produce high levels of FCF and has a good record of shareholder returns, balancing its subpar growth.
• Due to the maturity of its industry, FIS's growth potential is somewhat hampered.

Investment Thesis

I find it highly likely that Fidelity National Information Services (FIS) will miss Q4 earnings and find FIS's underlying business model and impressive profitability to be good enough to recommend a BUY if the earnings release leads to a dip in price.

Earnings Miss

One of the primary reasons I find FIS to be a potentially attractive investment is that signs point to an earnings miss, which may lead to a dip in price.

First, currency is a notable headwind for FIS. Nearly 25% of FIS ' business comes from overseas, which, coupled with a strong dollar throughout Q4, could be a detriment for FIS. Given a 10% move in exchange rates throughout FY 2022, FIS projected a loss of over $200 million. Given that the dollar remained strong in Q4, currency translation may continue to eat into earnings and may prevent FIS from meeting EPS expectations.

Second, while FIS has managed to delever somewhat, rising interest rates and a 2.9 leverage ratio would imply potential increases in interest expenses. Further, FIS themselves have identified some headwinds leading into Q4, such as near-term issues with lower termination fees and reduced license fees, potential signs of consumers transitioning towards non-discretionary industries, and overseas macroeconomic concerns (specifically in the UK).

Additionally, while FIS has established a goal of reducing its capital expenditures, it is unapparent as to the timeframe FIS is aiming for., with their Q3 earnings release stating that more details on this plan will come in 2023. Therefore, CapEx expenses will probably continue to contribute to the expense base through Q4.

Some of FIS' margins contracted in Q3, most notably its banking and merchant solution sectors. Despite growth in revenue, if margin contraction continued into Q4, which I find likely given current macro conditions and market sentiment, FIS may underperform earning expectations.

Perhaps most worryingly, analyst revisions have been largely negative over the last 30 days, with the average EPS expectation being reduced by nearly 2% . Historically, FIS has produced beats in 3 of the last 4 quarters, which makes these revisions even more reflective of a generally bearish sentiment on FIS in the near term.

Core Business

In the long term, however, I am quite fond of FIS' prospects. Fundamentally, its business is very stable as it is predicated on recurring revenue and secure contracts. Furthermore, consumer spending habits are increasingly shifting towards electronic payments, with Forbes projecting the industry to grow at a near 20% rate through 2028. FIS' (albeit limited) presence in this space should benefit its growth.

FIS' operating margin is very healthy, at nearly 11% TTM in September 2022. Other non-GAAP metrics are even more promising, with its EBITDA margin reaching near 30% (1.5x the sector median) and its levered FCF margin at 21.75%, which is very attractive for a stakeholder position. This profitability will be augmented by limited CapEx needs since FIS plans to slash these expenses beginning in 2023 (see its Q3 earnings release).

Analysis of FIS' growth prospects is promising -- FIS' net margin has improved significantly from its 2020 low (now 6.53% up from 1.31%), but it has still not yet regained its peaks. This implies room for further margin expansion once near-term headwinds peter out.

Furthermore, due to the recurring nature of FIS' revenue and limited reinvestment needs, FIS should be able to generate strong free cash flow in the coming years.

The caveat to this is that FIS' long-term growth prospects are far from leading, and that revenue growth has been progressively slowing since 2019. Therefore, while future earnings growth is likely, I believe FIS' price needs to drop just a bit more to justify the investment.

Valuation

Non-GAAP valuation measures are very favorable for FIS, and should an earnings miss lead to a dip in price they will become even more so. FIS' non-GAAP P/E is only 10.97x, about 42.8% below the sector medium. Further, their forward PEG is a staggering .15 -- 78.5% below the sector.

Comparing FIS to Fiserv and the S&P 500 over the last year, FIS' price has dipped to much lower lows than the broader index or its main competitor.

While it can certainly be argued that a major contributor to this was FIS' potential overvaluation, its current valuation metrics are much more promising. Aside from likely margin expansion, a stable revenue base, and its eventual relief from macro headwinds, FIS has a few other notable metrics.

Its dividend yield is 2.5%, which is exceptional given its future profitability growth. Its P/B hovers around .99. In fact, the only factors which Seeking Alpha gives a poor rating are based on EV ratios. If excluded, FIS' valuation becomes incredibly attractive.

*Its EV is semi-inflated due to high debt levels, though FIS has been working on delevering, as mentioned above, and decreases in CapEx should help with this problem. Additionally, should price fall in the case of an earnings miss, the subsequent decrease in market cap would also help these ratios.

FIS stands poised to make a commitment to profitability -- its limited necessity for reinvestment, high levels of stability, and gradual delevering all suggest positive future growth. Further, the short-term nature of many of FIS' headwinds (currency, recessionary sentiment, termination fees/license fees) makes FIS' current price seem reasonable given its long-term prospects. Since FIS' historical P/E has hovered much closer to 20x than 10x, I find now to be an excellent time to buy -- even better if price dips after an earnings miss.

Risks and Other Considerations

As with any investment, FIS is not without its risks. First, FIS' operates in a very mature industry, which makes periods of high revenue growth somewhat unlikely. If margin growth slows in the future, or projected cost reductions/deleveraging are not achieved, FIS becomes a much less attractive prospect. Of course, there is always also the risk that somehow FIS surprises on earnings, and this investment thesis is invalid. Fiserv ( FISV ) remains a very large competitor and a thorn in FIS's side as a more established company with better EPS, margins, ROE, and overall earnings. If FIS does not dip after a miss in earnings, it is difficult to say that FIS is the best investment in the industry given Fiserv's reasonable valuation and superior profitability/revenue. Essentially, the only reason I would find FIS to be a compelling investment is if its price dips down to, say, the mid-high $60's after an earnings miss. Otherwise, it is difficult to identify sufficient upside to justify an investment in FIS given the preponderance of other investments out there.

The Bottom Line

To reiterate my previous point, this BUY recommendation hinges upon a price dip after an earnings miss, which I find likely. Should this not occur, I do not find FIS to be a sufficiently attractive investment to justify a BUY. However, due to currency troubles, potential interest expense increases, margin contraction, and negative revisions, there is a distinct possibility that FIS will miss earnings. Should its price dip towards a sub 10x P/E ratio, I find its core operations to be sufficient to justify a BUY.

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