Fleetcor Technologies: Fuel Segment Showing Signs Of Improvement (NYSE:FLT)

Recommendation

With the Fuel segment showing signs of improvement and attractive growth opportunities in its non-fuel segments, I would recommend FLEETCOR Technologies (NYSE:FLT) as a buy. Despite the fact that FLT’s core businesses are vulnerable to macro pressure, I am confident that the company has the capacity to weather the storm and, if necessary, execute opportunistic M&A to emerge even stronger, especially since M&A is a strength of management.

Latest earnings highlights

In terms of revenue, FLT was able to outperform expectations by nearly 1%. Specifically, the Fuel segment drove the outperformance, while Corporate Payments and Tolls revenue was in line and Lodging and Gift revenue was slightly below. Adjusted EPS was $4.04, which is higher than the consensus estimate of $3.93. Initial FY23 guidance from FLT calls for organic revenue growth of 9 to 11%, margin expansion of 150bps, and adjusted EPS of $16.75 to $17.25.

The highlights of the earnings report, in my opinion, include management’s reiteration of its 10% organic growth guidance, driven by growth within corporate payments, which is consistent with 4Q performance. The good news is that FLT’s business is insulated from the SMB downturn because it is focused on the middle market. FLT also reported positive business trends, with direct corporate payments increasing by 27% in the fourth quarter and full AP increasing by 40% to 50%.

EV

Although I am concerned about how the switch to EVs will affect the bottom line, I am heartened by the slow but steady progress being made in Europe. FLT is expanding its customer base by selling EV solutions to new types of companies, such as charge point operators and EV car manufacturers. Management has also remarked on the positive unit economics of its hybrid fueling services for large fuel clients. For context, in some cases FLT has seen a 50% increase in revenue, indicating that there is room for FLT to improve its unit economics in the future.

Weakness in customer base

The organic growth for the Fuel segment slowed to 2% in 4Q from 5% last year. Regarding this, management has pointed to weakness among its recently onboarded micro US fleet customers on-boarded as the primary cause, in addition to the drag from last year’s non-recurring revenue. management attributes 75% of 4Q and FY22 bad debt to this subset of customers, driving the $4 million sequential increase in bad debt expense to $41 million. Softer Fuel volumes in the 4Q were also reflected in a 3% drop in SSS, due to the forced attrition of delinquent accounts. I believe it’s important to keep an eye on this because it has the potential to increase the biggest worry about FLT: bad debt. Nonetheless, I don’t see any reasons for concern for now, given management’s assurance that bad debt will remain stable in FY23.

Debt issue

The bad debt on FLT’s books has been a cause for concern. Given FLT’s handling of this in 4Q, (bad debt expense was relatively flat compared to the 3Q22), I think it does ease immediate concerns regarding the bad credit environment. Considering that most of the effect will be felt by micro merchants and that FLT will be limiting the credit box for these businesses, the overall impact on revenue growth should be small. In addition, management has indicated that bad debt expense for FY23 should remain unchanged from FY22 levels.

M&A catalyst

FLT has previously expressed optimism regarding the likelihood of large-scale M&A after valuations dropped. A more cautious tone was taken by management during the quarter, with the caveat that higher costs of capital necessitate greater certainty in an acquisition thesis. Since borrowing costs are so expensive, attention has seemingly shifted to reducing debt levels. While this may make financial sense in the short term, I believe that M&A are more effective at building long-term value. I remain optimistic that FLT will be able to acquire and successfully integrate additional assets because management has a proven track record of doing so.

Russia likely to be an ex-story

Managers have reported receiving multiple, highly-qualified offers for the asset. FLT has started the due diligence process, which involves investigating a short list of interested parties. To note, a buyer must be able to pay FLT from a location other than Russia in order to qualify. The good news for shareholders is that FLT’s current plan calls for them to use the proceeds to repurchase stock, mitigating any dilution that may have occurred. Closing of the deal is anticipated for late 1H23.

In any case, remember that guidance still takes into account the Russia branch. As a result, there could be a slight negative impact post the disposal from a P&L standpoint.

Guidance

Considering it implies Fuel’s growth rate will quicken in the second half of the year, I feel like the guidance is a bit too aggressive. In addition, the forecasted 10% organic growth presupposes there will be no macro weakening, which, based on trends through January, appears to be the case (but it might not be the case for the rest of the year due to so much going on). Not to say it’s impossible, but if FLT doesn’t meet this, it could be disastrous for the stock price.

Summary

Overall, I believe FLT’s long-term growth will be sustained as it expands into the corporate payments market and adds new offerings to its existing product lines. Furthermore, there is room for expansion through acquisitions, which could boost FLT’s earnings and diversify its business. While the aggressive guidance in FY23 may cause some concern, I believe these are minor blips in the context of a long-term investment in FLT stock.