2023-12-04 22:35:12 ET
Summary
- Hold rating recommended for BILL due to uncertain macro outlook and lack of positive catalysts in the near term.
- Weak macro outlook is going to continue directly impact near-term growth.
- Weakness in take rates should persist for the near-term as SMBs remains tight on their budget.
Investment action
I recommended a hold rating for BILL Holdings, Bill.com, ( BILL ) when I wrote about it the last time , as I remained uncertain about BILL's operating performance. In hindsight, the decision to stay on the sidelines was a smart move, as the stock fell by more than 50% since my last update. Based on my current outlook and analysis of BILL, I recommend a hold rating. I don’t see any catalysts or reasons for the stock to react positively in the near term as the macro outlook remains uncertain. Management initiatives to improve take rates are unlikely to show significant results in the near term as businesses remain wary about their budgets. Additionally, the market appears to be focused on the near-term (as seen from the stock price action), so any long-term bull case is off the table.
Review
Just to give a brief update on BILL 1Q24 earnings since this is follow-up coverage, total revenue grew 32.7%. Subscription revenues increased 7% to $62.4 million, including $52.9 million from the core BILL platform. Transaction fee revenue of $202.8 million saw ~30% growth, which includes 25% growth from the core BILL platform and 36% growth from Divvy (now known as BILL spend and expense management). Gross margins increased 30bps to 86.1%, while non-GAAP operating margins came in at 11%. As a result, BILL reported EPS of -$0.26, an increase from 1Q23 -$0.78.
Addressing the elephant in the room (the major stock drop), I think there are two key forces driving the bad results and negative sentiment surrounding the stock. The obvious culprit is the weak macro environment, which has significantly impacted the Small and medium businesses [SMB] operating environment in the US and directly impacted BILL’s volumes. That said, I believe this headwind is already somewhat embedded in estimates, as it is widely known that a bad macro environment will hurt SMBs the most. What I thought was the main force driving the share price performance was weakness in take rates. Management has noted a dramatic change in the way its larger and medium-sized clients are making payments through the platform, driven by a desire to cut costs. The same dynamic was seen in payment receivers as well, where they are exploring other methods of accepting payments in an effort to cut costs. Consequently, BILL is impacted as underlying businesses transition away from more costly payment methods such as virtual cards, cross-border payments, or Divvy transactions and towards cheaper ones such as ACH and cheque transactions. This drives a very bad near-term sentiment for the stock, as investors are likely to continue pricing in deteriorating take rates for as long as rates remain high (or are expected to go higher). The growth trajectory effectively becomes a macro bet, which by default will force investors to take a more conservative stance as nobody really knows where rates are heading.
As such, what we have on hand are:
- A very bad macro environment that directly impacts BILL’s core customers
- A “trade down” from expensive products to cheaper products that will impact take rates directly
- Uncertain outlook that cause investors to take a conservative stance
For the typical investor, I’d say these are very strong reasons to not buy the stock.
Now, personally, I don’t think the situation is as bad as it seems. Regarding the weakness in volume, I think some investors might be overly focused on the face value decline and not understand the underlying impact on BILL’s financials. In the quarter, while Divvy volumes fell, which has high revenue yields, note that this revenue stream has very low contribution margins given the associated costs (rewards and funding costs). Also, it was more of a deliberate decision by management to cut growth to improve profitability. They have been proactively tightening credit standards on corporate cards, which naturally hurts growth but improves profitability and will reduce credit losses. As such, I don't think the guidedown in Divvy’s TPV (from 35% to 20 to 25%) is as bad as it seems.
Regarding the weakness in take rates, while I agree, it is definitely bad for the near term. I have yet to see any reasons to believe this will be something structural that impairs BILL’s long-term growth. The reason for downgrading to a cheaper product seems to be more cyclical, as SMBs are keeping a tight budget to tide through this weak period. I still believe virtual cards have a strong value proposition, as they are much faster and more convenient than traditional payment methods like ACH. I believe businesses are willing to pay for these services once the macro environment turns for the better. As a matter of fact, I think BILL's product improvements, or future improvements, will lead to higher adoption levels. For virtual cards, a number of product enhancements targeted at lowering friction are in the pipeline. For cross-border, BILL is exploring ways to tailor pricing for large merchants, which should help in adoption, as I believe pricing is one of the key deciding factors given the commoditized nature of the product.
“And so when Rene mentioned accelerating some of the product improvements, we're going to make enhancements to remove as much friction as possible from and that was just one example from our ad valorem payment suite to make it easier for suppliers to adopt payments.” 1Q24 call
As such, I believe take rates will eventually recover and that the recent customer behaviour changes have not affected BILL’s long-term growth. However, from a stock perspective, I don’t think the stock price is going to see any positive actions, as it is a fact that macro continues to put pressure on SMBs, and I think the market is not going to give credit for management’s initiatives to improve the products until they see greater clarity on the take rate trajectory.
Valuation
Author's work
In my previous model, I believed BILL had a 41% upside based on FY26 figures. Given that the market is now putting focus on the near-term, I have revised my model to reflect my target price based on the near-term (FY24) outlook. With 1Q24 results, I no longer believe BILL can grow at the pace I expected (23%). Management guidance has also reflected this weakness, now guiding to $1.205–$1.245 billion in FY24 revenue, which I am basing my FY24 revenue assumptions on. The major revision in my model is that I expect multiples to stay at the current 4.9x forward revenue in the near term, as I do not see any catalysts or reasons for a positive re-rating to occur. If we compare BILL’s peers, the reason it has been trading at a premium is because it is growing at a much faster rate. Now that BILL’s growth is expected to be weak in the near term, it should not be trading at a premium.
Final thoughts
My recommendation for BILL remains a hold due to the absence of positive catalysts in the near term. The weak macro environment and take rates are unlikely to turn positive in the near-term as SMBs are likely to remain tight on their budget due to the weak macro environment. While improved product offerings and initiatives might reignite take rates in the future, given the current market sentiment and uncertainties, I think the stock is going to stay rangebound until growth outlook becomes clearer.
For further details see:
BILL Holdings: No Positive Catalysts In The Near Term