If you're looking for a company that's growing, profitable, undervalued, and has relatively little downside, I want you to look at financial technology (fintech) company Wex (WEX -0.31%) with me. It's under the radar and emerging from a difficult season, positioned strongly to deliver market-beating shareholder returns from here.
There are risks to a Wex investment, but this is my top value stock to buy now. Here's why.
Wex's business and resilience
Wex generates revenue by processing both fuel transactions for corporate fleets and business travel transactions. It also offers a software-as-a-service (SaaS) platform for corporate benefit programs.
When the COVID-19 pandemic started, few businesses were destined to perform as poorly as Wex. Driving diminished dramatically and business travel all but disappeared. But despite the odds stacked against it, Wex emerged from the pandemic slowdown and reached new highs for revenue and profitability. And it navigated the challenges without diluting shareholders, as the chart shows.
When I say Wex has a limited downside, I'm thinking of its performance during the pandemic. It's hard to imagine a more challenging operating environment than what it's already overcome. The business survived and has already rebounded to new highs for revenue.
Wex's resilience is due, in my opinion, to the importance of its services. Fleets need to guard against corporate fraud, and Wex's fuel cards collect relevant data to help. Therefore, companies are reluctant to drop the service. The same goes for Wex's corporate travel segment: Its customers need this service. And on a similar note, Wex says more than 80% of total revenue can be considered recurring.
Wex stock still trades below its pre-pandemic high. But, as we've seen, revenue has already recovered. And profitability is surging back to normal. Consider that in the second quarter of 2022, its adjusted earnings per share (EPS) was up 61% year over year to $3.71, whereas revenue was only up 30%. As profits return to highs, I expect the stock to start going up.
To better consider valuation, let's compare Wex to PayPal Holdings, Lightspeed Commerce, and Affirm Holdings. Admittedly, these aren't direct competitors. But they cover a wide swath of the fintech sector Wex inhabits. Wex trades at the lowest price-to-sales (P/S) valuation of the four, even though it consistently has a higher gross profit margin, as the next chart shows.
Wex is up about 900% since going public in 2005, beating the 250% return of the S&P 500 by a wide margin. Historically, buying Wex stock below a P/S ratio of four was an opportunistic move. And that's where it trades right now.
The long-term opportunity
Wex's fleet segment accounted for 63% of Q2 revenue. And this segment is very dependent on processing fuel transactions. Some long-term investors might envision a future in which most fleet vehicles are electric, indeed a risk for Wex.
However, Wex isn't blind to a possible electric vehicle (EV) future. It's already building out its products and services in the e-mobility service provider space (eMSP) -- locating and offering access to in-network EV charging stations without needing to operate the charging stations. With the range of services it aims to provide, Wex believes it can generate as much revenue from an all-EV fleet as it does from gas fleets today.
Fully electric fleets are still a future possibility. However, Wex's current reality is a $24 billion addressable market estimated to be growing 5% to 10% annually. For comparison, Wex has generated $2 billion in trailing-12-month revenue, leaving plenty of room for growth.
In 2014, Wex set long-term revenue growth goals of 10% to 15% annually. It surpassed this goal, on average, through the end of 2019, giving CEO Melissa Smith (who's still in place) credibility.
At the end of 2018, Wex's management set new goals that it hasn't lived up to since. But I think we can all agree that an impossible-to-foresee pandemic shouldn't damage management's credibility. The business has now rebounded. And in March, management reset guidance going forward for 10% to 15% annual revenue growth and 15% to 20% adjusted annual EPS growth.
I believe Wex can hit this guidance. If the company achieves the high-end of its guidance, as it usually does, revenue will double over the next five years. Assuming that revenue doubles and its already reasonable valuation remains unchanged, the stock should also double. Historically, stocks that double over five years tend to beat market averages.
It might not be the flashiest company. But all these factors combined are why Wex is my top value stock to buy right now.