2023-05-08 05:27:02 ET
Summary
- Fair Isaac reported impressive 2Q23 results, with a strong performance in both the Scores and Software segments.
- Management raised its FY23 revenue guidance, indicating improved visibility into the full-year revenue outlook.
- Despite the positive outlook, FICO's high valuation of 33x forward PE and 28x 2-year forward PE reflects high expectations.
Overview
Fair Isaac Corporation ( FICO ) provides tools to manage risk, fight fraud, and meet strict government regulations. The typical clients are banks, collection agencies, government, insurance, etc. The 2Q23 results were spectacular, reflecting strong performance in the Scores and Software segments, and importantly, FY23 consensus figures are not more or less in the bag with management increasing FY23 guide for revenue and EPS. While the earnings outlook is positive and 2Q23 results were really good, my concern is the high valuation that FICO is trading at today - 33x forward PE and 28x 2 year forward PE. This tells me that there are a lot of expectation embedded into the share price today. For instance, consensus has EPS ~2x in 3 years and 2.5x from LTM2Q23. While I believe FICO has strong pricing power in the Scores business and a Software business that is growing very well, both which enables significant operating leverage, I recommend a hold rating as I would prefer valuation to be cheaper (at least near or below its average) before investing.
1Q23 earnings
FICO reported a 6.5% increase in revenue to $380 million in the 2Q23. Scores revenue increased by 8% year over year, owing primarily to growth in the B2B . The Software revenue, on the other hand, increased by 4.8% year on year, accompanied by a 16.6% increase in ARR. However, EBITDA margins fell by 50 basis points to 50.5%, owing primarily to one-time costs of approximately $10 million, two-thirds of which were carried forward from the upcoming quarters, i.e., Q3 and Q4 of 2023. In total, FICO reported EPS of $4.78.
Raised guidance
In light of improved visibility into the full year revenue outlook, management has increased its FY23 revenue guidance from $1.46 billion to $1.48 billion. Management's comment that they've added more conservatism to the updated guidance compared to historical years may be what's prompted higher expectations for FY23 performance. They pointed out, in particular, that only a fraction of special pricing increases were factored into the outlook, which, to me, is the same as saying they can beat guidance whenever they want and sets the stage for more beat-and-raise performance in the coming quarters. Another way to look at this conservative guidance is that, if we look at the Scores segment 2Q23 results, we can see that they posted a healthy 8% y/y revenue growth, which is well ahead of the 7% y/y guided revenue growth. The underlying growth driver, which is pricing, also tells us how much pricing power FICO has. Customers have not been defecting in droves in response to price hikes because of the significance of FICO scores.
Software performing well
The software industry has continued to thrive in 2Q23, with ARR reaching $614 million. The quarterly results for both platform and non-platform businesses were better than expected, with platform ARR growth speeding up from 46% to >60%. I think this is a crucial indicator because it shows that growth has stopped slowing down and is instead reflecting the impact of the robust bookings experienced in the previous two quarters. The average contract value of new orders has remained stable at $23.3 million. Importantly, management highlighted that the pipeline remains robust, and the demand for the platform has not displayed any macroeconomic sensitivity. Furthermore, C-level discussions with clients have been highly strategic, emphasizing the importance of the platform to their business. In fact, management has noticed a shortening of the sales cycle time. These are all excellent quantitative and qualitative indicators of future growth and its visibility. The strong valuation and share price, in my opinion, can be largely attributed to these remarks. Customer retention was also excellent, with a dollar-based net retention rate of 114%, which increased sequentially.
Score business
Scores revenue increased by 8% to $199 million, with the decline in B2C scores being the main factor in the slow growth. The lower demand for pre-screen scores, combined with the higher base from last year (thanks in part to a sizable licensing deal with a client in Latin America), have made the growth look weaker than it is, in my opinion. Mortgage is the standout subsegment; its origination revenue grew 90% in the quarter, which was shocking given the precipitous drop in US mortgage origination volumes.
Margin
I think the timing and unusual events that contributed to the weaker-than-expected margin in 2Q23 are the only real explanations for this. As the expenses had been moved out of 3Q23 and 4Q23, I think it just makes for a more rapid acceleration of earnings. This means that the numbers for FY23 are now largely locked in, and the consensus has adjusted their predictions accordingly.
Conclusion
In conclusion, 2Q23 results were impressive, with strong performance in the Scores and Software segments. Management has raised its FY23 revenue guidance, and the pipeline remains robust with demand for the platform showing no macroeconomic sensitivity. However, FICO's high valuation of 33x forward PE and 28x 2-year forward PE reflects high expectations, and I would recommend a hold rating until the valuation becomes more reasonable.
For further details see:
Fair Isaac: Strong Business Performance, But Valuation Is High