Fair Isaac Corporation: High Quality And Durability At A Sensible Price

Summary

• FICO is a high-quality company in the financial service industry.
• Future growth and profitability are highly predictable.
• Strong cash flow and buyback provide cushions against stock market volatility.

Michael Vi/iStock Editorial via Getty Images

With 60 years of history, Fair Isaac Corp. (NYSE:FICO) is a leading fintech company providing analytical software solutions and services for financial institutions and customers. It has been one of the best-performing stocks before the pandemic. However, the recent stock price is under pressure and lagging behind the S&P 500. I think FICO is still a high-quality and durable business with solid fundamentals, and the current weakness offers a great long-term opportunity to buy the stock for an above-average return.

Data by YCharts

Business

Overall, 89% of FICO sales come from the financial service sector, with the largest geographic market in the Americas representing 80% of sales. The company recently simplified its business into two segments: scores and software.

The scores segment (FICO Score) offers the most used credit risk measures for nearly all major financial institutions on banking, credit card issuing, mortgage lending, auto loan origination, etc. The algorithms of these scores are directly integrated into the data flows of national consumer reporting agencies, including Experian, TransUnion, and Equifax (accounted for 38% of sales). These consumer reporting agencies charge users for each score generated by FICO algorithms, and FICO earns a fraction of the fee for each calculated score. Currently, the scores segment counts about half of the company sales (654M).

Source: investor presentation

The software segment provides software solutions to help business customers with customer engagement and fraud protection. Lots of these products use transactional data, which is very messy and complex. FICO is doing the heavy lifting on automating and standardizing transactional data for business decision-making. In recent years, FICO has been working hard to build a super app called the FICO platform which will offer all software in one place and help smaller customers to understand FICO products better. Currently, the FICO platform only accounts for 14% of the company's annual recurring revenue. There should be lots of room for future growth in this area.

Earnings and Growth prospects will continue

As the chart below indicates, EPS, free cash flow per share, and revenue per share all increased in the last ten years. Improving EBITDA per employee and lower SG&A expenses also indicate higher operational efficiency in the company. If we only look at the pre-COVID times, FICO has delivered an excellent performance with 8% CAGR revenue growth and 12% adjusted EBITDA growth. So there is no doubt that FICO can make money and grow its business given the long sales cycle (270 days) and sticky relationships with their customers.

Data by YCharts

In 2021, FICO generated 1.3B sales and 391M net income. Scores segment has increased 125M (24%) primarily due to higher prices and mortgage volumes. Software segment sales didn't look good with a 103M decrease. However, 68.6M of the decrease is due to the shift of company revenue recognition on subscription sales regarding point-in-time recognition. Another 21M decrease is due to the divestiture of their C&R business.

Source: 2021 annual filings

And the software segment actually becomes more stable and durable as we see more ARR (Annual Recurring Revenue) with increasing proportions from the FICO platform. The dollar-based net retention rate is also reaching 106%, indicating the capabilities for organic growth.

Source: 2021 annual filings

As of the 2022 outlook, the company is guiding revenues 1.35B (6% increase when adjusted for divestitures) and 397M non-GAAP net income. Lots of large companies in the financial industry rely on FICO's knowledge and analytical expertise, and they use FICO products on a daily basis. The cost of switching to other vendors is very high. With the user base growing bigger, FICO can enjoy network benefits as more customers will integrate FICO platforms into their workflows and decision making, which also helps improve FICO's algorithm and keep its products the best in the industry.

Moreover, e-commerce and remote working need FICO's analytical capabilities to engage customers and control business risks. Given the enormous potential demand in these areas, I think FICO will continue to deliver better-than-average financial performance since its business is a critical infrastructural component of our digital economy.

Cash flow and shareholder return

Data by YCharts

FICO is a robust cash flow machine and efficient capital allocator. Since the current CEO Will Lansing joined the company, FICO's free cash flow to asset (26%) ratio has kept rising, and it is currently higher than Moody's (MCO) and Coca-Cola's (KO). This allows them to have enough capital to invest in research and development or involve in M&A without external funding.

Ample cash flows also give the management options to reward shareholders. In the last three years, 1.3B worth of stocks has been repurchased. A new 500M repurchase program was just announced on Nov. 30, 2021. I think future share buybacks will continue since there are no signs of weakening on company free cash flow

Risks and evaluation

As Marc Andreessen said, "Raising prices is a great way to flesh out whether you actually do have a moat. If you do have a moat, the customers will still buy because they have to. The definition of a moat is the ability to charge more." Although FICO has sticky products and services, its sales were recognized through a small pool of large corporate customers (e.g. banks, credit card issuers) who are a lot larger than FICO. This may impact FICO's pricing power. If the macroeconomics or market demand is weak, it may have no capability to negotiate favorable margins for its product offerings with those giant corporations. The effort to develop the FICO platform product in the last several years aims to solve these issues by diversifying user profiles and attracting more median-sized business customers. We should keep an eye on these product offerings and check their efficacies in the future.

Another risk is the health of the US housing market since mortgage origination is a significant sale driver for FICO. US House sales are currently impacted by inflation, housing shortage, or demographic trend with no signs of disappearing. This could be a long-term headwind for future earnings.

All that being said, the good news is that FICO has a proven track record of navigating the aforementioned challenges. This is absolutely a high-quality company. With 391M net income guided for 2022, FICO is at the low end of the PE ratio in history. As Warren Buffett said, "Our goal is to find outstanding businesses at sensible prices, not a mediocre business at a bargain price." The current 9.46B market cap only gives FICO about 24x forward PE. Considering the strong cash flow generation and buyback, the current share price should be a great entry point.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of FICO either through stock ownership, options, or other derivatives. 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.

Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.