WEX - Wex: Good Entry Point For A Quality Compounding Fleet Manager

2023-10-23 17:48:25 ET

Summary

• Wex has achieved consistent revenue growth by growing its mobility, benefits, and corporate payments business segments.
• The company's CEO, Melissa Smith, has played a key role in transforming Wex and diversifying its operations.
• Wex has a history of positive earnings surprises and continues to grow its core business through new customer wins and expanding relationships.
• Wex is a buy up to $190, with the potential to double your investment in 5 years.

Editor's note: Seeking Alpha is proud to welcome Lakeside Capital as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Premium. Click here to find out more »

Portland, Maine-based Wex (WEX) was founded in the 1980s by A.R. Wright as Wright Express Corporation with a postpaid fuel card product. Its largest business today is fleet management. This business model is not going to get anyone’s pulse racing, but a peek under the hood reveals a modern company with a track record of growth and a promising future.

Revenue

I like to see consistent revenue growth, as margin improvements can only take a company so far. Going back to the start of the current CEO’s tenure in 2014 (more on the CEO later) Wex has grown revenues at a 14.3% annual rate, resulting in annual revenues nearly tripling over this 9-year period from $716M to $2.06B.

Segments

How has Wex achieved this consistent growth? By growing three distinct business segments: Mobility, Benefits, and Payments. Benefits and Payments now make up 45% of total revenue, up from 40% five years ago.

The Mobility business has been impacted recently by lower fuel prices. The company estimates this impact at over $50M of revenue in Q2, per the Conference Call . The good news for Wex is that gas prices have reversed in the last couple of months, which should provide a tailwind in Q3.

The company continues to have success adding vehicles to the core fleet management business, with vehicles under management increasing 8% YOY in Q2 to 18.9 million.

The Benefits segment increased the number of managed HSA accounts by 11% YOY, and increased the deposits held in those accounts by 25% to $3.9B (10-Q, p.38). The Benefits segment also offers protection from inflation and high short-term interest rates. Of the $3.9B of deposits in HSA savings accounts, ~$2.8B (72%) was held at Wex Bank and $1.1B (28%) was held at 3rd party banks (10-Q, p.20). The average cost of the deposits held at Wex Bank was only 0.11%.

On the revenue side, the company earned $42M in total interest from HSA accounts in Q2. What was the interest rate earned on HSA deposits held at 3rd party banks? It was 4.33% on average, up from 1.57% last year. If the Fed keeps short-term interest rates at current levels, Wex should continue to generate substantial income from the delta between the costs of HSA accounts and the interest rate earned on them.

The market does not appear to be giving Wex enough credit for the Benefits segment. I do not spend a lot of time on sum of the parts analysis, but as a quick valuation check, HealthEquity (HQY) recently reported 8.2 million HSA accounts and 15 million total accounts (including CDB accounts) with an anticipated 2023 revenue $980-$990 million, which is a little more than 1.5x Wex’s annualized Benefits revenue from Q2. The market has a $6.3B value on HQY (at a 36 PE ratio) vs. an $8.1B valuation for all of Wex including Mobility and Payments as well as the Benefits business. (Note: this is not an opinion on HealthEquity or its current valuation, as I have not done any work on the company.)

I also like companies with high recurring revenue. Across all three segments, Wex estimated Q2 recurring revenue at 80%.

Earnings

Past Earnings

Over time, the price of a stock will follow its earnings. Wex’s preferred metric for reporting earnings is Adjusted Net Income (ANI). Over the last 5 years, Wex has grown ANI at a 13.4% annual rate. Wex’s last 4 quarters have been negatively impacted by a drop in the price of oil. Bank of America estimates that earnings would have been $0.15 higher without the negative impact of gas prices in Q2.

Q3 Estimates

13 analysts have an average estimate of $3.74 for Q3, per Seeking Alpha data. Wex is guiding for $3.70 at the midpoint, which is based on an average U.S retail fuel price of $3.70/gallon (coincidentally). The average retail fuel price was substantially higher in the last 2 months of the quarter, which could lead to a positive earnings surprise.

Source: Energy Administration Information

Also, Wex has a history of positive earnings surprises, beatings estimates 11 straight quarters by an average of 18 cents. Wex reports Q3 earnings before the bell this Thursday, 10/26.

Source: Seeking Alpha's Wex Earnings History

Growth Opportunities

Core Business

Wex continues to grow its three core businesses. This growth comes from both expanding relationships with existing customers and new customer wins.

Across our Corporate Payments segment, we were pleased to sign a number of renewals and expanded relationships with customers, including a large regional banking partner and European online travel agency On the Beach. In mobility, we continue to sign new customers across the portfolio and see the benefit of increased marketing as we continue to add small fleets through digital channels. New signings this quarter include Merchant Leasing, a competitive leasing company win. Merchants is a major fleet management company and will be using both our mobility and corporate payment solutions.

Source: Q2 conference call from Seeking Alpha transcript

Wex's core growth aspirations are reflected in the job postings on its website, with 84 current full-time openings, including 51 in Product Development and IT and 7 Sales positions.

Wex Venture Capital

Companies that are able to compound earnings growth over a long period of time focus on innovation and new markets. They are always looking for the next opportunity. On the Q2 conference call, Wex announced an investment of up to $100M by its venture capital group to be made by the end of 2025. These investments will focus on "early and growth-stage companies that are innovating on how the energy transition impacts corporate mobility, including areas such as fleet electrification, the EV charging ecosystem, energy management and optimization and adjacent technology."

The goal of Wex Venture Capital's $100M investment is "to bring both internally developed and partnered solutions to the market as we aggressively build our capabilities in this dynamic space. We believe the years ahead are a crucial moment for businesses with mixed fleets, and we're proud to lead and help them through the energy transition."

Acquisitions

In Q2 Wex signed an agreement to acquire Ascensus Health and Benefits for $180M.

[Ascensus is] a leading tech-enabled provider of employee benefit accounts with a diversified portfolio, including HSAs, FSAs and other benefit accounts. We are excited about this deal as it will both increase our scale in the Benefits segment and expand our benefits product offering by including Ascensus' complementary Affordable Care Act compliance and verification capabilities… We have known the Ascensus team for many years and look forward to welcoming them to the WEX family. We believe our combination will only strengthen and deepen our offerings for employers, consumers and partners alike.

Wex has completed a number of acquisitions in the last several years. In 2021, Wex acquired the HSA assets of its custodian bank for $400M. The timing of this acquisition seems prescient now, as the HSA balances have been a major source of income since the Fed started raising interest rates. The company entered the health benefits space with the $532M acquisition of Evolution1 in 2014.

The balance sheet appears to be in good shape for additional acquisitions, with $193M of corporate cash and $893M of borrowing capacity at the end of Q2 (prior the close of Ascensus). The leverage ratio as defined by the company's credit agreements stood at 2.8x, comfortably within the long-term target range of 2.5x to 3.5x.

Leadership

Wex has been led since 2014 by CEO Melissa Smith . She has been with the company for 26 years, working in a variety of leadership roles including CFO at the time of its IPO in 2005. She has played a key role in transforming the company from its fleet manager roots:

She also substantially diversified the company, moving from a primarily U.S.-based, fleet-centric business to a global enterprise with offices in 14 countries and more than 5,500 employees worldwide.

Ms. Smith’s bio notes that she was raised on a farm in Maine, and she formed her values there. I pay a lot of attention to a company’s leadership. I see value in Melissa Smith’s story, starting with her youth, through her 26 years at Wex, and her long list of accomplishments in 9 years as CEO.

Buybacks

I like companies that opportunistically buyback shares when the market puts them on sale. Wex started significant buyback activity when the average weekly closing price was $164 in Q2 of 2022, and continued the program over the next 3 quarters, ramping up to $134M in Q4 of 2022 when the average weekly closing price dipped below $160. By Q2 of this year, the company dropped the buybacks to less than $10M, when the average weekly closing price was over $180.

During the 6-quarter period from Q1 2022 and Q2 2023, Wex spent over $400M on buybacks, removing 4.7% of outstanding shares at a time when the market was undervaluing the company. Wex did issue nearly the same number of shares during the previous 2 years, resulting in a smaller net reduction of shares when viewed over a longer period.

Going forward, Wex will continue with a balanced approach to capital allocation, per the Q2 conference call:

When the Ascensus transaction closes, we would expect to use some of our available borrowing capacity to close the deal. We will continue to manage capital allocation between organic investment and M&A and returning capital to shareholders.

Cost Cutting

I like companies that are always looking to cut costs, even while they are growing at a rapid clip. Wex has a goal of cutting $100M in annual run rate of expenses out of the company by the end of 2024. Per the Q2 conference call, "To date, much of the benefits we have seen have been offset by the cost involved in achieving them, but we expect to see margin improvements as we lap those expenses." Wex expects $50M to be reinvested in the business, while the other $50M would go to improving margins. If the company is successful in removing $50M of run rate costs, this could add ~$1.15 to annual earnings beginning in 2024-2025.

Analysts

Six analysts have raised Wex’s target price in the last 90 days, with an average price target of $230, which is 22% higher than the current stock price of $188 at the time of this writing.

Risks

Stock-Based Compensation

Morgan Stanley estimates that Stock Based Compensation was 1.3% of sales for all public companies in 2022, and 4.0% of sales for IT companies, with smaller companies tending to have higher SBC. I like companies that safeguard their share counts and are reluctant to dilute current shareholders, although I recognize that SBC is a key part of the compensation package to attract and retain certain employees.

The SBC rate at Wex has more than tripled in the last 10 years, and it is now running higher as a percentage of sales than the average public company, even the average IT company. This by itself does not overcome the other favorable metrics for Wex, but I plan to keep an eye on it, and also do further research on who is receiving this compensation, and how it is being used as a part of overall compensation to employees.

Recession

A general economic slowdown would impact Wex's more cyclical Mobility and Payments businesses. Also, Wex makes a lot of money when gas prices and interest rates are high. If a recession is accompanied by a drop in gas prices and lower interest rates, this would have a "double whammy" effect on Wex's revenue and earnings.

Valuation

I'm a fan of the PEG valuation method favored by Peter Lynch and others. Wex has historically grown earnings at compound rate of 13% (with recent results depressed by low gas prices), and the current P/E ratio is ~13 ($188 per share/our 2023 ANI estimate of $14.70). A PEG ratio of 1 is a good entry point for a quality company with a proven track record of growth. Wex is a buy up to $190. If the company can grow ANI at 14% for the next 5 years with a stable multiple, we’ll double our money, with the potential for greater returns: (1) if the market rewards this quality grower with a higher multiple; and/or (2) with dip-buying accumulation along the way.

For further details see: