Recently, I bought shares of niche payments-solutions company WEX (NYSE:WEX).
WEX operates a payments network. This is similar to credit cards and an important business considering the ongoing rise of digital transactions. But WEX's system is special -- its fuel cards and other services collect information so companies can monitor their employees' spending, preventing fraud. This niche service is likely to stay in demand. WEX can leverage its customer relationships to offer additional services from all three of its categories: fleet (fuel and vehicle maintenance), travel, and health. And it can leverage its leadership position to be the consolidator in its space, acquiring smaller players.
That's why I think it can beat the market, but here are four reasons to like WEX stock right now.
1. Multi-bagger potential
According to WEX, its addressable market across its three business segments allows for $21.5 billion in annual revenue. For perspective, the company generated $1.72 billion on its top line in 2019. FLEETCOR Technologies (NYSE:FLT), a rival fintech company, looks at the opportunity a different way. It estimates there's over $42 trillion spent annually worldwide on front-line business expenses (like fuel and travel). For perspective, WEX handled $82 billion in transaction volume in 2019.
From either company's perspective, this points to a much larger opportunity than what WEX has already captured.
According to its 2018 investor-day presentation, the company is targeting roughly $3 billion in revenue by 2023. This is attainable for two reasons. First, when looking at the size of the market, $3 billion is still a small piece of the pie -- the market can accommodate this growth.
More importantly, CEO Melissa Smith has a track record of hitting these targets. In a 2014 investor day presentation, Smith set a goal for 10% to 15% annual revenue growth. For 2014, WEX generated $818 million in revenue. In 2019, it generated $1.72 billion. That's a 16% compound annual growth rate (CAGR) -- ahead of management's guidance.
WEX exceeded guidance before, and its track record indicates it can achieve that 2023 target, potentially fueling multi-bagger returns.
2. Not as vulnerable as I feared
When the COVID-19 pandemic hit, WEX felt its effects in all three business segments. Fleet-segment revenue went down, because fuel prices cratered. Travel-segment revenue decreased due to travel restrictions. And health-segment revenue fell since people weren't undergoing elective surgeries.
It's hard to imagine a more difficult situation for WEX. The second quarter of 2020 reflected an entire period of adverse circumstances. Nevertheless, revenue only fell 21% year over year to $347 million. That's a big drop but nowhere near what I expected. Furthermore, WEX reported earnings of $1.66 per share, maintaining profitability.
Generating 79% of pre-pandemic revenue and staying profitable while businesses slashed corporate spending speaks volumes to the stability of WEX's operation. The stock is lower risk than I feared.
Furthermore, WEX isn't losing customers -- spending is just temporarily down. Consider its health segment. In the second quarter, software-as-a-service (SaaS) accounts were up 15% year over year. These customers didn't spend as much, but there are more of them on the platform than ever before. When normal spending returns, I expect revenue to surge higher, reflecting the growth in accounts.
3. Current valuation
When buying a stock, I'm most concerned with identifying best-in-class companies with long-term opportunities. Valuation is a secondary factor but a valid consideration nonetheless. Right now, many stocks are trading at historically rich valuations, placing me on the sidelines.
Not the case with WEX stock: It hasn't fully recovered from the market crash, still trading almost 40% below its 52-week high. And compared to FLEETCOR, it looks like a relative bargain.
FLEETCOR stock enjoys a premium over WEX but not necessarily because of its superior results. In 2019, FLEETCOR grew revenue 9%, while WEX was up 15%. And during the coronavirus-affected second quarter, FLEETCOR revenue fell 19%, approximately in line with the 21% decline at WEX. In short, their recent results are comparable, but their valuations are not.
If WEX can hit $3 billion in revenue and return to its historical price-to-sales multiple of around five, then it would have a market capitalization of $15 billion. Given its current market cap of $6.5 billion, that's about 130% upside for the stock in just the next few years. If the market ever gave it a valuation comparable to FLEETCOR or other payment-processing companies, the upside is much higher.
4. I buy stocks
I'm a net buyer of stocks. This means I seek to buy more than I sell during any given time period, whether the market's up or down. I've adopted this investing philosophy, because I'm convinced it's futile to try to time the market, and I've seen how the stock market goes up more often than it goes down.
Since stocks regularly climb, and investors cannot consistently time the top or the bottom, that means they should regularly look to add high-quality businesses to their portfolios. And as I recently opened a position in WEX, investors should at the very least put it on their watchlists.