October 26, 2020

Wex Is Cheap and Will Rebound As Economic Transactions Rise

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Wex (NYSE:WEX) is a corporate payments technology and benefits company that will thrive as the economy and travel transactions take off over the next year. WEX stock looks particularly undervalued as its Q2 financial compression has bottomed out.

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Wex is a specialized payments company focused on corporate customers, fleets, and also has a corporate benefits division. It makes revenue from traditional payment processing and also SaaS (Subscription as a Service) revenue in its benefits division.

During Q2 its payments divisions took a hit, but its benefits SaaS revenue kept growing. The company stopped providing guidance for the rest of the year.

But it stands to reason that as economic growth picks up the number and value of economic transactions will increase. That will pump up its payments-related revenue. I expect this will start to show up in Q3 and more so in Q4 as lockdown restrictions across the country have been lifted.

For example, the company reported Q2 earnings had fallen 44% on an adjusted basis from $99.6 million in 2019 to $53 million. On an earnings-per-share basis (EPS), this was a 47% drop.

Last year the company made $9.20 per share but this year analysts polled by Yahoo! Finance expect it to make $6.67. That is a slightly better 27.5% drop. Moreover, next year, these analysts expect to see Wex make $8.56 EPS, up 28%.

Free Cash Flow Powers the Company

Wex has a strong history of free cash flow (FCF) generation. For example, even though earnings fell during the first half, its FCF grew from $31 million last year to $684 million. That is an amazing jump. You can see this in the company’s latest 10-Q statement.

It was led by a massive decrease in its accounts receivable. As economic activity slowed, the number of accounts that kept paying down their bills to Wex increased dramatically.

Wex’ corporate payment clients wanted to clear their bills so as to not fall into arrears for fuel, for which is what Wex cards are primarily used. You might not have expected that, but it shows the power of Wex’s payment corporate payment franchise.

Granted, this is likely to occur fairly infrequently in a corporation’s life cycle. But it sure helped that it occurred during this latest downturn.

Another way to see the power of the company’s FCF is to compare it to revenue in any period. This is its FCF margin.

For example, during the first half of 2020, Wex made $778.7 million in revenue. But, as mentioned above, its first FCF was $684 million. That means that its FCF margin was 87.8% (i.e., $684 million in FCF divided by 778.7 million revenue). This is an extremely high margin that most companies would wish they could generate.

What To Do With WEX Stock

Right now, Wex stock looks fairly cheap. For example, based on analysts’ expectations mentioned above, it is trading at just 16.7x next year’s EPS. That is fairly cheap.

For example, other payments related companies are much more expensive. For example, PayPal Holdings (NASDAQ:PYPL) trades at 41x next year’s earnings. Square (NYSE:SQ) trades at 132x earnings.

These are not direct competitors since they are consumer payment oriented whereas Wex is a corporate payment company. But it gives you a sense of the comparative valuation discrepancy.

No one ever seems to pay attention to Wex stock since it is not as sexy as these other payments companies. But it is much cheaper.

And, in addition, it has the free cash flow to make acquisitions and solidify its corporate payments franchise. That is what it did at the beginning of 2020. Barron’s discussed the benefits of the two payment companies it bought in January when it interviewed Wex’s CEO, Melissa Smith. She said the savings would amount to $25 million per year.

WEX stock is the kind of stalwart, cheap and enduring FCF-generating company you want to have in your portfolio over the long term. The only drawback I see is that Wex does not pay a dividend. Once it starts to do so I would take a closer look at the company.

On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.

Mark Hake runs the Total Yield Value Guide which you can review here.

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