Description

WEX

WEX is a long idea that includes elements of both a ‘compounder’ and self-help, is a beneficiary of tax reform and a favorable risk/reward from here even if the overall market sees multiple compression. This payments business is in an oligopolistic fuel card market and gets less attention from Wall Street than its M&A-driven listed competitor Fleetcor (FLT). Both stocks had been flattish over the past 2-3 years (until 3Q17 earnings season) despite earnings growth (ex-fuel prices) as volatility in gasoline prices and higher fraud at WEX (card skimming at gas stations) have masked its true earnings potential. As Wex solves and laps the fraud issue with better software into 2018 (chip cards not yet required at pumps, so fraudsters flocked there), margins will inflect higher. With a longer horizon, WEX is a high-quality business with secular growth and multiple ways to win.

WEX will be a moneymaking idea because: (1) high-quality fuel card business with strong barriers to entry via scale and high switching costs, (2) attractive duopolistic industry structure with secular tailwinds (cash  à card), (3) improving competitive position from recent client wins like Chevron, (4) large international opportunity, particularly in Europe with oil majors moving towards outsourcing fuel card processing, (5) overlooked healthcare payments business (white-label software for benefits administration) that is 15% of revenue and growing organically 20%+ with secular tailwinds, (6) a solid management team that has executed on a number of acquisitions, including its entrance into healthcare payments in 2014, and (7) reasonable valuation at 19x earnings for ~20% earnings growth. Over time, WEX should be worth $170 based on ~20x 2019 earnings.

Business Overview

WEX has three reportable segments: Fleet solutions, Travel & Corporate Solutions and Health and Employee Benefit Solutions.

Fleet Solutions (63% of revs, 27% EBT margin)

o   Fleet vehicle payment processing services for commercial and gov’t fleets

o   Primary customers are trucking companies with commercial fleets, oil companies and convenience stores

o   Value prop: provide trucking companies with fuel savings and better control on spending and provides merchants with increased gas volumes and higher-margin purchases inside the store

o   Services ~10.5mm vehicles.  Mgmt estimates it has 17% market share in the US (41mm vehicles), 3% market share in Europe (56mm vehicles) and 5% market share in APAC (30mm vehicles).

o   High US fleet retention rate >97%

o   Closed-loop network meaning WEX has direct relationship with the merchant and the fleet, and only WEX transactions can be processed on these networks

o   Revenue

§  Growing revenues estimated HSD/LDD organically ex-fuel prices

§  Payment processing fees (45% of fleet solutions revenues): receives ~130bps/transaction from merchants.

§  Finance, account and other servicing fees (55% of fleet solutions revenues). Late fees are included in this bucket and are 16% of total fleet solutions revenue.  Late fees are calculated based on the greater of a minimum charge or stated late fee rate multiplied by outstanding balance subject to the late fee charge.  Late fees in 2016 increased $36mm or 53%.

§  29% of fleet revenues (18% of total company revenues) exposed to fuel prices.

o   EBIT margin declined over last couple yrs due to fuel prices; historically margins were high 30s.

Travel & Corporate Solutions (21% of revs, 48% EBT margin)

o   B2B payments/virtual payments primarily in the online travel market

o   Each transaction is assigned a unique account number with customized credit limit and expiration date. Virtual cards limit fraud and unauthorized spending. Primary competitor is eNett (owned by TVPT)

o   WEX focused in NAM, but also has operations in Europe and APAC; eNett focus is APAC + Europe.

o   Strategic relationships with 4 of the largest OTAs in the world, including EXPE and PCLN

o   Volumes growing 20%+ organically, but take rate compression has led to 1H17 revenue decline

Health and Employee Benefit (16% of revs, 12% EBT margin)

o   SaaS platform for consumer directed healthcare payments

o   Partner with health plans, 3rd party administrators, financial institutions, payroll companies and software providers to provide a SaaS product to support employers’ healthcare benefits programs and administer flexible spending, health saving and reimbursement accounts

o   Revenue generated from SaaS based monthly fees to partners and interchange fees from spending on customer debit cards issued under flexible spending, health savings and reimbursement accounts

o   Cards are branded with either Visa or MA and operate on restricted open loop network.

o   Mgmt estimates market size at $1.8bn; WEX has 8.5% mkt share. Revenue growing >30%+ organically

Thesis / Discussion

High quality fuel card business in an attractive industry

o   Fuel card industry is underpenetrated and fragmented.  Industry estimates suggest the US commercial fleet market is 40% penetrated and Europe only 20% penetrated (more on Europe opportunity below).  Plenty of M&A opportunities where both FLT and WEX have been active, though WEX to a lesser extent.

o   Duopolistic industry structure. FLT and WEX are the only 2 companies of scale in fuel cards, besides perhaps Elavon. WEX historically had been priced lower than FLT in an effort to gain share, but is using the FLT umbrella to increase prices.

o   High barriers to entry created by broad merchant base.  The size of the merchant network is an important factor in the customer decision process.  WEX and FLT have spent significant time and money to build out their merchant networks, creating a barrier to entry.

o   High switching costs.  Industry participants suggest that fleet companies rarely switch because of the hassle in doing so, especially larger fleets.  Fleets could use open loop cards, but these aren’t competitive with fleet cards in terms of reporting, controls, etc.

o   Demonstrated pricing power.  With clear value being delivered to the fleet operators and merchants, both WEX and FLT have been able to increase prices. In 2014, WEX began its “price modernization” strategy and has been steadily increasing price since.  WEX late fees ranged from 0-3.75% 1H15, 0-5.50% in 2H15, and 0-6.99% 2H16.  The weighted avg late fee rate was 4.9% in 2016, compared to 2.9% in 2015.

WEX positioned to gain share.  WEX won Chevron contract from FLT (conversion Q218, GS estimates ~$40mm annual contribution or 4% of revs).  They have also had a number of smaller wins 2017 YTD (including Pilot Flying J) and renewals (including ExxonMobil and Imperial Oil in North America late 2016, and Sunoco and Circle K in 2017).  Demonstration of recent customer wins/renewals and heightened focus on FLT ancillary fees suggest a strong and potentially improving competitive position.

Europe represents a significant opportunity.  Most of the oil companies in Europe had historically maintained their operations in-house, but a shift to outsourcing is in motion.  Commentary from WEX and FLT management suggest up to 2 Europe fleet card outsourcing contracts to be awarded over next 6-9 months (rumored to be BP and Statoil).

Tailwind from fuel price recovery.  From 2013-2016, WEX’s wtd avg fuel price declined $1.38 (or 37%). According to the 10k, each one cent decline in domestic fuel prices results in $1.2mm decline in revenue.  Thus, fuel price declines have accounted for $165mm in revenues and assuming this flows through near 100% margins ~$2.70 in EPS.  The recovery in oil prices should provide a tailwind to margins and earnings going forward.

Healthcare and travel business underappreciated.

o   Healthcare business is growing 30%+ organically.  Representing only 15% of total company revenues, it seems as though the quality and growth outlook of this business are underappreciated.    

o   Travel business growing volumes >20%+ organically, but revenues 1H17 have been down slightly due to interchange rate compression (71bps Q416 to 53bps Q117).  This is from a telegraphed customer renewal with a large OTA and renegotiation with Mastercard (hurts revenue, but neutral to earnings).

New fraud measures should decrease credit losses.  Credit losses have increased significantly over the last 3 quarters as EMV chip readers have not been implemented at gas pumps.  In response, WEX has put in place enhanced measures to restrict fraudulent card authorizations and fraud detection technology for its cards, using software developed by IBM.  It’s primary competitor FLT has not experienced the same degree of fraud losses, suggesting this should be a fixable problem.  A 1bp difference in credit losses has a 5c impact on EPS (or 80bps).

Management team quality underappreciated.  Investors have historically been partial to FLT in part because of Ron Clarke’s reputation, particularly as it relates to capital allocation.  Life is sleepier up in Maine, but WEX management is not getting credit they deserve (FLT management is a high bar to comp to!).  WEX has executed on a number of acquisitions in recent years (M&A detail below), including an entrance into the healthcare payments space in 2014 (paid ~$600mm for 2 acquisitions; some analysts estimate WEX’s healthcare business now worth $2bn).

Affordable valuation.   WEX trades at 19x earnings and 13x EBITDA.  This is slightly above its 5-yr averages of 18.5x earnings and 11.5x EBITDA.  A market multiple may not be prohibitively expensive for a high quality business.

Risks

Fuel prices. 29% of fleet solutions revenue (18% of total company revenues) are exposed to fuel prices.  Assuming the fall through is nearly 100% incremental margin, fuel prices have a meaningful impact on earnings.

Industry pricing practices. The Capital Forum and Citron FLT short reports have brought late/ancillary fees in the fuel card business under the microscope. Our research suggests that these fees are in line with practices in the larger payments ecosystem and unlikely to become a hot topic under the current regulatory regime.

Customer losses.  This has not historically been an issue in the fuel card business as WEX has 97% customer retention, but still something to monitor.  If WEX’s travel business were to lose one of the big OTAs (i.e. EXPE or PCLN), this could be a significant problem.

Higher credit losses.  WEX has seen higher than expected losses from fraudulent transactions (card skimming) in some states including Texas and Florida.  They have put in place enhanced measures to restrict fraudulent card authorizations and fraud detection technology for its cards.

Reduction in fuel demand from fuel-efficient vehicles. TSLA bulls may see this as a long-term risk.

Valuation

Yes, the secular trends in the payments space have led to serious multiple expansion over this cycle from networks (V/MA) to acquirers/processors (GPN/VNTV/TSS) and more. Perhaps hardware and bricks & mortar oriented payments businesses have not seen that expansion (PAY, ING.FP, HAWK). The fuel card networks still trade below peak multiples due to fuel price volatility and other discrete issues that we think are in the rear view. As we near the goal line on tax reform, WEX would be a sizable beneficiary of a lower effective rate on domestic earnings as well. While WEX shares have run over the past few months, the ratio of reward/risk remains favorable and could be a quintessential dip-buying opportunity the next time we see one.

Over the past 5 years, WEX has traded at an average discount of 2.5x to FLT and premium of 2.5x to the market.

Management Overview

Melissa Smith, CEO

·       Jan 2014 became CEO of WEX.  Prior to that, she was President 2011-2013 and CFO 2001-2011. She is a ‘lifer’ at Wex – makes for a boring LinkedIn page but is refreshing / rare for a CEO these days

Roberto Simon, CFO

·       Joined WEX as CFO Feb 2016

·       CFO of Revlon from 2014-2016.  Left at the same time of a CEO change.

·       From 2011-2014, CFO of the Colomer Group which was sold to Revlon. Prior to that, he served as VP, Finance Americas & Africa at Colomer

Management Incentives

Short-term incentive plan

o   Based 50% on operating income and 50% on non-fuel price sensitive revenue

Long-term incentive plan target mix

o   60% PSUs. 2-yr performance goals.  Weighted 60% adjusted net income and 40% non-fuel price sensitive revenue.

o   20% stock options. 3-year vesting.

o   20% RSUs. 3-year vesting.

M&A Overview

Expanded and diversified their product offering through a number of acquisitions

o   July 2016 - EFS (US fuel card) for $1.4bn, representing company’s largest acquisition to date

o   Nov 2015 – Benaissance (US healthcare) for $81mm

o   Aug 2015 – 49% UNIK (Brazil corporate payments) for $46mm

o   Dec 2014 – Exxon Esso (European fuel card) for $380mm

o   July 2014 – Evolution1 (US healthcare) for $532mm

o   Oct 2013 – FastCred (Brazil fuel card)

o   Oct 2012 – FleetOne (US fuel card)

o   Aug 2012 – UNIK (Brazil corporate payments)

o   May 2012 – CorporatePay (UK travel card)

Divestments

o   Jan 2015 – PayCard ($20mm)

o   July 2014 - Pacific Pride (fuel, $50mm)

Relevant Slides

Fuel Cards

Virtual Payments

Healthcare

Catalyst

• Margin expansion from lower losses on fraud (better software = less fraud at the gas pump in an EMV chip world)
• Secular penetration of fuel cards continues. Customer wins in Europe with oil majors
• Bringing pricing umbrella up further to match FLT on fees
• Growth / scale in healthcare and travel segments in 2018-19. If peer TVPT spins/sells eNett would be a mild catalyst to recognize value
• Tax reform certainly helps headline EPS
• Company enters crypto mining (kidding...)