A Deeper Look At Wex's Financials

| About: WEX Inc. (WEX)

Summary

Wex's growth rate is concerning in light of the bloated stock.

An excess returns model shows a large opportunity cost to investing in Wex.

Investors should aim to buy a deep dip when the stock is more fairly valued.

Wex Inc. (NYSE:WEX) has fallen 21% in the past month. I was asked to look into this company by a Seeking Alpha reader of my article on Synchrony Financial (NYSE:SYF), who asked for a similar analysis on this payment processor.

This is a welcome addition to the articles on Seeking Alpha, as most of the articles dip into Wex's business model, ignoring the financials. Wex is not a new company - with 10 years of financial data, we should be able to see some trends and gauge its health. This is what I plan to do in this article.

Invested capital outpacing free cash flow should be concerning

Wex has seen a surge in invested capital that has come with the growth of its business. Yet, free cash flow has bounced all over. As a running average, free cash flow is negative:

The comparison between free cash flow and invested capital gives us a good indication of the business's growth:

Date

Invested Capital

Free Cash Flow

2006-02-10

242.2

-357.8

2007-02-09

398.3

48.0

2008-02-08

411.8

-149.5

2009-02-13

604.0

281.4

2010-02-12

549.1

-51.0

2011-02-12

966.3

-379.5

2012-02-10

1004.6

18.3

2013-02-08

1525.5

-358.7

2014-04-25

1587.8

0.1

2015-03-02

2414.9

238.3

Click to enlarge

The ratio of free cash flow to invested capital gives us the capital return on invested capital (CROIC). Because FCF varies so wildly per year, we benefit by using the running average instead. This gives us a measurement of Wex's growth rate:

Though the stock has increased sharply over the years, the growth rate does not support this. The low/negative growth rate and free cash flow lead to the inability to intrinsically value Wex via discounted cash flow. Luckily, we have many other tricks to check if the stock is in line with the financial data.

A recent study tried to tie financials to future stock price movements and found the EBITDA/EV ratio correlated to stock price changes. Yet, the trend in EBITDA/EV in comparison to the stock price trend has not converged. In fact, even recently, with the dip in Wex, these two ratios have moved in opposite directions:

Often, in these kinds of analyses, I find the stock price trailing the fundamentals. But this is a rare case where the stock price seems to be leading the fundamentals. Because that is impossible, the only conclusion at this point is that the price is fueled solely by sentiment, at least looking at these ratios.

When I look at the financials for Wex, things look better, but still bad. For example, the rolling average of earnings is up, showing that its business model is working in expanding the company:

But if WEX is moving independent from the financials, we should not care too much about the fundamentals. You probably disagree - and so do I. Thus, we should keep digging to find fundamentals that are actually predicative of stock price movement.

Valuation

It is in the valuation that we see some fundamentals in line with the stock. In using the excess returns model, which you can read about here, here, and here, we find the growth of the stock to mimic the growth of the implicit valuation as per the company's excess returns - how the company's return on equity exceeds the industry's. Both have headed upward in tandem, except for the dip in 2009, in which they both moved downward:

Thus, the trend of the excess returns valuation can likely predict the trend in the stock price of Wex. However, the intrinsic valuation has always been under the stock price. The conclusion is that sentiment and expectations are priced in.

The dip in the stock should be seen as a correction. The ERM valuation accounts for opportunity cost, and the fact that it's 50% of the stock implies that investors would be better off investing their money in other companies or vehicles. Wex might have a bright future ahead, but at these price levels, it's overpriced.

Even the liquidation model, which gives a lower limit based on liquidating the company and paying the sold assets to the shareholder, shows Wex to be grossly overpriced. Shareholder equity is at roughly 25%, meaning shareholders would gain 25% of the assets in the case of liquidation:

A quick calculation sets the lower limit of the stock (ignoring excess returns and speculations) to be $27.26. Could sentiment plus excess returns triple the market price? Or, using the excess returns model, could sentiment alone double the market price of WEX?

If you think the company's fundamentals will be doubly good in a year, sure. But looking at the growth rate and free cash flow, this is unreasonable. With nothing especially interesting in Wex's future, speculation and sentiment should not double or triple the price of the stock.

Most of the company's business endeavors, such as its acquisition of Evolution1, have likely been priced into the stock. But the oil prices, which directly affect Wex's bottom line, haven't seemed to affect the stock - unless that's the dip we are currently seeing. My theory is that investors' beer goggles are disappearing, allowing them to see the company for the fundamentals that it's based on.

If this is the case, the stock price of Wex should continue to drop to a fairer value, at least 1.5x the price of the ERM model - which is a generous estimate, in my opinion. Perhaps Wex will continue to grow, and it will almost certainly see a bounce as oil returns. However, now is not the time to buy.

The stock is overpriced. Buy the dip when the dip is deep enough. Aim for a buy price of around $52.

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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.