WEX - WEX: Still Resistant To Monetary Tightening

Summary

• Management has raised WEX's guidance targets leading into Q4.
• Strong Q3 financial performance shapes a financially sound competitive positioning.
• Flume expands into the $25 trillion Accounts Payable Market, high growth prospects lie ahead.
• Leadership continues to support share buyback programs; uniquely growing from a high inflation environment.
• Wall Street Analyst Consensus is bullish on WEX stock.

Introduction

Formerly Wright Express Corporation, WEX Inc. (WEX) is a global leader in financial technology solutions, providing financial technology services in the Data Processing and Outsourced Services Industry . The company also operates and generates revenue through three segments: Fleet Solutions, Travel and Corporate Solutions, and Health and Employee Benefit Solutions. Year to date, WEX stock is outperforming the broader market, gaining 7.57% while the S&P 500 ( SPY ) declined 7.67% of market value in the same time frame.

I find this recent outperformance to be justifiable as I noticed many bullish tailwinds that would continue to support WEX's stock price. Because of this, I strongly emphasize my opinion that WEX stock should be bought before February 9th's Q4 2022 Earnings for many reasons: Q4 2022 strong financial targets from Q3, ramp up on stock buybacks, Flume's exciting growth prospects, and more. Let's dive into the primary drivers for my bullish outlook.

Q4 2022 Outlook

Following Q3 2022, WEX delivered strong top-line growth and their business model has shown strong resilience despite the geopolitical and inflationary environment. To recap the solid quarterly performance, here's a helpful quote from CEO Melissa D. Smith in the Earnings Call :

On an organic basis, which excludes the impact of fuel prices and foreign exchange rates and an accounting presentation change, revenue grew 22% compared to the prior year's period. This performance reflects the power of our growth engine and the reoccurring nature of our business. Total volume processed across the organization in the third quarter grew 41% year-over-year to $57.5 billion, driven by strong performance in each of our segments. Record quarterly revenue paired with the scalability of our business model resulted in adjusted net income per diluted share of $3.51, an increase of 43% compared to the same quarter last year. I'm really pleased with our results this quarter.

This organic growth has been robust and volume increase has been great to see despite the uncertain macroeconomic environment. In addition, the increased profitability metrics should be a good indicator to investors as well. Following this impressive performance, WEX also readjusted guidance to expect strong financial growth in the foreseeable future. Most notably, management projects ~$570 to $580 million in revenue, representing a ~15% to 17% YoY increase, and ~$2,302 million to $2,312 million in FCF, representing a ~24% to 25% YoY change. Given the financial uptrend in recent quarters, I believe that these assumptions are fairly attainable and reasonable as company guidance usually tends to be more conservative to avoid high expectations for investors. Now, with a more optimistic forecast, I believe that management is more confident on outsized financial performance and lends us confidence in the company's financial prospects.

As seen in WEX's Q3 2022 Earnings Presentation :

WEX's financial position following Q3 remains healthy and strong. With ~$759 million in cash and cash equivalents , WEX has significantly reduced their net debt levels to an all-time low of ~$822 million (this is counting WEX's short-term investment balance of ~$1.4 billion). The decreasing leverage ratios and access to liquidity make us feel comfortable about the company's balance sheet. Furthermore, the new maturity date for credit loans and tranche A term loans is April 1st, 2026 after raising commitments and competing debt refinancing on April 1st, 2021 . The near-term liquidity risks are minimal, and I believe that the company will be able to push out debt maturity levels once credit markets loosen.

Growth Catalysts

I believe that Flume will shape out to be a game changer for WEX. Flume has gained 450,000 consumers since its full product launch in Q2. And in WEX's Q3 2022 Earnings Call, CEO Melissa D. Smith recapped on its success:

And so, we think that this creates a unique opportunity for us to deepen wallet share that we have within the small business portfolio, the 450,000 customers that we have. It is a model that's SaaS+, so we charge SaaS fees plus other transaction-related fees. And so, it also gives us an opportunity to broaden and diversify our revenue stream. But I'd say, it's early, and we will talk more about it as we go through next year.

WEX's gain of 450,000 customers has helped Flume expand to the $25 trillion Accounts Payable Market . Flume has integrated with QuickBooks Online and managed roughly $2 million in payment volume for small businesses while successfully meeting consumer demand. This product certainly exceeded my expectations, and investors should realize the bright future growth prospects for Flume. New services like this should help propel the company's top line higher and bring a level of growth to the business overall.

In addition, I noticed that WEX has been successfully leveraging off the high interest rates, and CFO Jagtar Narula has provided a bit of context:

Interest rates have also risen to the point where we will see some benefit from interest rate escalator clauses in our fuel merchant interchange rates. In the low rate environment that we've been in for the last few years, we have not talked much about this lever, but we have the contractual ability to raise interchange rates as interest rates go higher, once we hit a negotiated floor level in rates. Given all of this, over the long term, we see the impacts of interest rate changes as more balanced.

Though the annual inflation rate seems to have peaked in June 2022 of the 9.1% record high and slowed down to 6.5% in December 2022, this still remains more than three times above the Fed's 2% target. However, I believe that the rates will remain high or go even higher as inflation persists in our economic landscape. Such a view adds to the bullish sentiment that WEX will be able to grow its earnings as it increases interchange fees. I'll attach a helpful graph below for reference on the last 10 years' inflation rates .

Shareholder-Friendly Policies

Per WEX's capital allocation priorities, leadership continued to ramp up share buyback programs to $650 million purchasable by December 31st, 2025 in order to drive stock demand and value. It's my view that such a robust share buyback program is due to the fact that management is confident in the financial stability of WEX and the overall growth tailwinds ahead. Below is WEX's business model on capital allocation thus far found in the Q3 2022 Earnings Presentation . I believe that management will continue to elevate shareholder value as financial performances still remain strong.

Stock Valuation

After analyzing WEX's strong financial performances, I decided to value WEX stock using the Discounted Cash Flow ('DCF') method with conservative approaches to result in more accurate and reasonable results. In recent years, WEX's Free Cash Flow ('FCF') has stabilized from the COVID-19 pandemic growth boost, so I based my DCF on the average FCF value from 2017 to 2021 to result in a more constant FCF value of $354.09 million. I then assumed a 2% terminal growth rate beginning 2028 to best match long-term inflationary expectations. For years 2023 to 2028, I'm assuming an FCF growth rate of 7.98% as I believe that WEX will grow at the FCF CAGR from 2015 to 2019 based on the tailwinds from Flume and a high inflationary environment. Lastly, I used a WACC of 7% as the discount rate. With these assumptions, my DCF resulted in an intrinsic price of $213.34 which presents a 13.2% upside from its current levels.

I noticed that Wall Street is also generally bullish about this stock. Yahoo Finance reports 13 analysts with a mean price target of $193.77 and the range spanning from $157.00 to $293.00. This is further evidence that my valuation is supported by research analysts and that WEX stock is undervalued by the market.

Geopolitical Risk Headwinds

WEX in its 2022 Annual Report publicly expressed their concerns with the ongoing political environment:

We are exposed to risks associated with operations outside of the United States, which could harm both our U.S. and international operations.

With the Russia-Ukraine war showing no signs of stopping since Russia's invasion on February 24th, 2022, the global economy is forecasted by experts to deteriorate as interest rates remain high and inflation persists. The global economy is facing headwinds and the OECD expects that rising global interest rates should add substantial debt burdens to firms and governments. Such a scenario would make it difficult for companies especially like WEX to operate to its fullest potential as WEX offers products and service internationally such as the recent Driver App launch in Australia . Despite these risks, I remain optimistic on the company's stock as management has proven to be capable of adjusting their business model and its balance sheet remains healthy yet strong.

Final Thoughts

Again, I believe that WEX stock is an optimal investment during this time for many reasons. Most notably, the company's strong financial performance has shaped a financially secured positioning, leading to leadership ramping stock buybacks and raising its guidance targets. WEX is also uniquely benefitting from the high interest rate environment, which I see as likely to continue for the foreseeable future. However, geopolitical headwinds remain as the economy is expected to slow. Lastly, my conservative DCF model on the stock resulted in a price target that implies 16.35% upside from its current price. All in all, I recommend a "BUY" on WEX stock before the next earnings announcement this week.

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