We review our investment case on FleetCor (FLT) 5 months after our initiation with a Buy rating in July, taking into account recent developments including the release of Q3 2020 results on November 5.
Since our initiation, FLT shares have gained only 2.9%, underperforming the S&P 500 by approx. 10 ppt. With the end of the COVID-19 outbreak finally in sight, we believe FLT is on track to deliver an upside of more than 50% by 2023 year end.
Buy Case Recap
Our Buy case assumed that the quality of FLT’s businesses meant its earnings growth and valuation multiple would both recover after COVID-19:
- We believe FLT’s payment businesses have strong network effects, revenue models that offer strong growth potential, good operational leverage and are deeply integrated into their customers’ business processes
- We believe FLT can achieve a long-term structural revenue CAGR of approx. 6%, including 5%+ for Fuel, 15% for Corporate Payments, 10% for Tolls (in US dollars), and zero for Lodging
- Including operational leverage, with a margin uplift of 20-50 bps each year, we believe long-term EBITDA CAGR would be 6.5-7.0%; including buybacks, we believe long-term FCF Per Share CAGR would be 11%
- Because of COVID-19, we assumed FCF Per Share to decline by 27.5% in 2020, based on a revenue decline of 20% in Q2-Q4 (and 15% for the full year), but to be substantially back to 2019 levels in 2021.
- We assumed FLT shares would re-rate back upwards after COVID-19, with Free Cash Flow (“FCF”) Yield returning to 4% (equivalent to a 23x P/E), the middle of its historic range before the outbreak.
- We assumed other external factors, including the FTC lawsuit against FLT’s Fuel business and long-term macro trends (especially fuel prices) to be relatively benign, or at least have limited impact.
FLT’s financial results since our initiation have been better than we expected, and we believe our investment case is on track, as we will explain below.
Better-Than-Expected Results & Visible Improvements
FleetCor has been doing better than expected during COVID-19. Where we had assumed a 20% year-on-year organic revenue decline through Q2-4 of 2020, actual revenue declines were 17% in Q2 and 12% in Q3:
As shown above, for most segments, while year-on-year growth was still negative in Q3, the quarter showed a clear sequential improvement; the one exception was Tolls, which had a positive 3% growth in both Q2 and Q3.
FLT’s overall (volume-weighted) customer retention has also continued to improve, from 90.7% in Q1 2020, to 91.0% in Q2 and 92.3% in Q3.
Looking at each of FLT’s key categories in more detail, there were pockets of growth in Q3 volumes, including Full AP (Accounts Payable) in Corporate Payments (up 20% year-on-year), Tolls (up 5%), and Fuel B2B (up 7%) in Brazil, and Fuel in Russia (up 8%); Virtual Card volume was flat:
FLT Volume Trends in Key Categories (Q2 & Q3 2020)
Source: FLT results presentation (Q3 2020).
In Fuel, where the U.K. and Western & Central Europe had much larger declines than the U.S. in Q2, they had improved to show similar figures in Q3.
In Corporate Payments, new sales have also been improving, from 54% of their prior-year levels in Q2, to 80% in Q3 and an expected 90%+ in Q4.
We believe these sequential improvements and pockets of growth, despite travel restrictions and widespread disruption to Travel & Entertainment, showed the strong structural drivers behind FLT’s businesses.
Continuing Buybacks & Acquisitions
Despite COVID-19, FLT has continued to deploy cash productively in both acquisitions and buybacks. Year-to-date, management has spent $1.3bn, including the pending acquisition of AFEX, exceeding the 2019 full-year figure:
AFEX is a B2B cross-border payments provider that FLT has agreed to acquire for $450m in September 2020. Growing at mid-teens before COVID, AFEX is expected to show flat financials year-on-year in 2020. The transaction is expected to close in Q1 2021, and AFEX is expected to add $0.25-0.50 to FLT’s run-rate cash EPS once integrated.
Share buybacks have totalled $788m year-to-date, including 1m shares purchased at an average $238 per share during Q3. They are expected to continue, with the Board having just authorised another $1bn of buybacks before Q3 results.
P&L Stabilising & EPS Helped by Buybacks
The benefits of the sequential stabilization and buybacks described above were visible in FLT’s P&L, helping to limit the year-to-date EPS decline to 6.1%:
- Q2 2020 revenues were down 18.8% year-on-year, partially offset by reported OpEx falling 10.7%; non-GAAP net income was down 23.1% and EPS was down 19.9%
- Q3 2020 revenues were down 14.1% year-on-year, partially offset by reported OpEx falling 8.9%; non-GAAP net income was down 13.9% and EPS was down 10.0%
FLT P&L (2020 Q2 & Q3)
Source: FLT company filings.
Management did not provide an explicit 2020 outlook but stated that Q4 expenses would be 10-12% lower year-on-year, and commented that they were forecasting Q4 sales to be only 10% lower:
This quarter, we’re really not sure what to expect, whether volumes will further recover or whether they’ll just flatten and plateau where they are. So we are planning a couple of things. We’re going to manage operating expenses down about 10% to 12% below last year, and we are forecasting sales to further strengthen, hopefully, coming in more than 90% of the prior year.”
Ronald Clarke, FLT CEO (Q3 2020 earnings call)
At $260.30, relative to 2019 financials, FLT shares are trading at a 21.1x P/E and a 4.3% FCF Yield; the company does not pay dividends:
FLT Earnings, Cashflows & Valuation (2016-Q3 2020)
Source: FLT company filings.
Despite the decline in Net Income, improvements in working capital meant that FLT’s FCF was actually approx. $300m higher year-on-year for Q1-3. Working capital improvements were mainly in account receivables, as lower volumes and a tightening of credit meant FLT saw a large net cash inflow.
FLT’s Net Debt/EBITDA was at 2.77x at Q3 2020, rising from 2.43x at 2019 year end but still manageable. The actual net debt figure was $3.0bn at Q3, compared to $2.8bn at 2019 year end. FLT had $1.6bn in total liquidity, from both available cash and an undrawn revolver, sufficient for its needs.
FLT’s share price has largely been moving only sideways in the last few months, remaining more than 15% below the $300+ level before the COVID-19 outbreak, despite recent positive news on vaccine development:
FLT Share Price (Last 1 Year)
Source: SEEKING ALPHA (16-Nov-20)
Illustrative Return Forecasts
We have amended our return forecasts for FLT, switching from FCF to EPS as our valuation metric, raising our estimates and assigning a higher exit multiple in light of FLT’s stronger resilience during COVID-19. Our assumptions include:
- 2020 EPS of $10.86, 7.9% lower year-on-year (was 27.5% lower), implying an approx. 10% year-on-year EPS decline in Q4
- 2021 Net Income to be back to the 2019 level which, with the share count being 5% lower, means an EPS growth of 19.0% from 2020
- Thereafter, we assume Net Income to grow at 7.0% and the share count to fall by 3.5% each year, giving an EPS growth of 10.9%
- 2023 year-end exit P/E to be 25x, compared to 21.1x at present and 23x assumed previously, but within FLT’s historic range
In addition to FLT’s resilience, we believe a 25x P/E is justified by its long-term double-digit EPS growth and also the “lower for longer” rates outlook.
These give an exit share price of approx. $395 at 2023 year-end, compared to approx. $370 in our July article. With shares currently at $260.30, this implies a total return of 52% (14.3% annualised) in just over 3 years:
FLT Illustrative Return Forecasts
Source: Librarian Capital estimates.
FleetCor has been doing better than expected under COVID; sequential improvements and pockets of growth were visible in Q3 results.
Management has continued to deploy cash productively, with more share buybacks and the $450m AFEX acquisition in the quarter.
With shares largely moving only sideways in the last few months, FleetCor trades at a 21.1x P/E and a 4.3% FCF Yield on 2019 financials.
We continue to believe FleetCor can achieve a sustainable double-digit EPS growth and re-rate upwards after the end of the COVID outbreak.
At $260.30, including a return to a 25x P/E, shares can deliver a total return of 52% (14.3% annualised) by 2023 year-end.
We reiterate our Buy rating on FLT.
Note: A track record of my past recommendations can be found here.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.