2023-08-24 08:00:00 ET
Summary
- NerdWallet's actual revenue growth might surprise on the upside, considering that the company is likely to engage in acquisitions going forward.
- NRDS has multiple profitability improvement levers, which puts it in a good position to achieve above-expectations operating margins.
- My rating for NerdWallet stock is raised to a Buy, as I think that NRDS has the potential to deliver positive surprises in areas like revenue growth and margin expansion.
Elevator Pitch
My investment rating for NerdWallet, Inc. ( NRDS ) stock is a Buy. My earlier update for NerdWallet published on May 4, 2023 was focused on the company's quarterly revenue guide and its shareholder capital return plans.
With this current article, I write about NRDS' potential to engage in mergers & acquisitions (M&A) and the levers that NerdWallet has to expand its profit margins. I view these as potential surprises which could act as catalysts for the stock, and this explains why I have upgraded my rating for NerdWallet from a Hold to a Buy.
Inorganic Growth Potential
Wall Street currently sees NerdWallet's revenue growing by a pretty decent +12.5% CAGR from $538.9 million in fiscal 2022 to $766.9 million for FY 2025. It is reasonable to assume that most sell-side analysts wouldn't have incorporated potential M&A transactions into their top line projections for NRDS, and this is an area where NerdWallet could potentially surprise the market.
I have identified a number of indicators which suggest that NerdWallet's actual inorganic growth might exceed expectations.
Firstly, NRDS acknowledged at the company's Q2 2023 earnings call in early August that "there's definitely a lot of activity out there in terms of potential acquisitions." At its most recent quarterly results briefing, NerdWallet also emphasized that "we just got to be opportunistic" and "we care a lot about pricing and relative value" when questioned about potential M&A. An analysis of NerdWallet's management comments implies that there are no lack of M&A targets for the company, and NRDS seems keen to consider acquisitions at the right valuations.
Secondly, NerdWallet hasn't been as active with share repurchases as what I would have expected, and this could potentially mean that the company is setting aside capital for value-accretive M&A deals. In my May 4, 2023 article, I highlighted that NRDS "announced a new $20 million share buyback program" at the beginning of May this year. But NerdWallet is estimated to have spent a relatively insignificant $1.3 million on share repurchases by the end of June 2023, as per the company's Q2 2023 shareholder letter .
Thirdly, the company has the financial strength to be aggressive on the M&A front. NerdWallet boasted a net cash balance of $67.1 million (source: second quarter shareholder letter) on its books as of June 30, 2023, which is equivalent to almost 10% of its current market capitalization and more than a full year of its consensus FY 2023 normalized earnings.
In terms of the focus for potential acquisitions, NerdWallet is likely to be interested in either vertical integration deals or market & business expansion transactions. For example, NRDS bought over On the Barrelhead last year, which Seeking Alpha News referred to as "a robo-advisor for consumer debt" that was combined "into NerdWallet’s existing teams, brand, products and technology." Separately, NerdWallet acquired its foreign peer, Know Your Money, in 2020 to venture into a new geographic market, the UK.
In summary, I expect NRDS to report above-expectations revenue expansion going forward on the back of new acquisitions.
Profitability Improvement Initiatives
NerdWallet's future operating profit margins are another area of potential surprises for investors.
NRDS' normalized EBITDA surged by +63% YoY from $12.7 million for the second quarter of 2022 to $20.7 million in Q2 2023, and this was +16% higher than the sell-side analysts' consensus EBITDA forecast of $17.9 million (source: S&P Capital IQ ). The company's better than expected EBITDA for the recent quarter was largely attributable to an improvement in operating profitability, or more specifically a +430 basis points expansion in EBITDA margin from 10.1% for Q2 2022 to 14.4% in Q2 2023.
Moving ahead, NerdWallet has guided at its second quarter results call that its EBITDA margin is expected to increase by approximately +3 percentage points to 15% or above for full-year fiscal 2023. In my opinion, NRDS' actual operating profitability is likely to surprise the market in a positive manner.
One profitability improvement lever is optimizing NerdWallet's revenue mix. At the company's Q2 2023 earnings briefing, NRDS mentioned that it "will lean into verticals where we're seeing positive momentum to deliver profitable growth." In the most recent quarter, NerdWallet's insurance and banking verticals did reasonably well, while the company's mortgage and credit cards verticals underperformed. This could serve as an indication of which specific verticals NRDS will prioritize in the near term to boost its profit margins.
Another area of potential profitability improvement for the company is sales and marketing costs. NerdWallet's sales and marketing expenses as a proportion of total revenue declined by -2 percentage points YoY from 71% in Q2 2022 to 69% for Q2 2023, as NRDS cut brand spending and focused more on campaigns as part of the company's marketing efforts. There is room for NRDS to further lower its sales and marketing costs, as it places a greater emphasis on higher ROI (Return On Investment) sales initiatives.
Also, there are areas where NRDS could realize more significant operating leverage. As an example, NerdWallet's research & development (R&D) expenses are fixed costs that don't vary with sales. NRDS noted at its Q2 earnings call that it has become "more efficient with our use of headcount and the investments in product and engineering" in a bid to lower fixed R&D costs.
I am of the view that NerdWallet could deliver operating margins which are better than what investors and analysts expect.
Closing Thoughts
NRDS is now trading at consensus forward next twelve months' EV/EBITDA and normalized P/E ratios of 6.6 times and 10.4 times (source: S&P Capital IQ ), respectively. NerdWallet's shares are inexpensive, and I think that positive surprises such as above-expectations top line growth and EBITDA margins should help to bring about a re-rating of the stock's valuations.
For further details see:
NerdWallet: Expecting Positive Surprises (Rating Upgrade)