Description

Overview

Corpay is a high-quality company on nearly every metric: consistent double-digit earnings growth, >50% EBITDA margins, 92% retention rates, 24% ROIC, 100% FCF conversion and with a founder/operator at the helm who understands capital allocation. Yet it trades at a very low multiple from an absolute, historical, and relative to the market perspective. At the current valuation of 14x 2024 P/E, I see significant re-rate potential on top of 15-20% EPS growth.

From IPO in 2010 until the pandemic, Corpay (fka Fleetcor) compounded at ~31% CAGR. Since then, the shares declined by ~15%. This is purely from a de-rating as NTM P/E fell from 25x to 13.5x. From 2019-2023, revenue grew at 9% and EPS at 10% per year. This is below their long-term EPS guidance of 15-20%, but certainly not pointing to a break in the business model. Especially when considering borrowing costs more than doubled (otherwise EPS grew at >12%) and this period including Covid. Two reasons for the re-rating are the EV overhang on the fuel card business and the growing corporate payments segment. The latter further complicates the business. Prior write-ups (3x long / 1x short) primarily focused on the fuel card business. Since the last write-up, the company rebranded itself from Fleetcor to Corpay to reflect its shift away from the fuel card business. They also increased their corporate payment’s segment with two sizeable acquisitions, pushing the segment’s revenue contribution from 26% in 2023 to 40% by 2026. This part of the business has received little attention, but it’s clear that this is where the business is heading. This write-up aims to fill this void.

Brief background

CPAY has some layers to peel as it operates several businesses. What they have in common is that they help companies control B2B expenses and/or facilitate payments, are very sticky (90-95%+ retention rates), high margins (40-50% GAAP EBIT margins) and have some sort of network effect.

I briefly describe the other segments for the sake of completeness. For more background, especially on the fleet card business, I recommend looking at prior write-ups on both FLT and WEX.

Fuel (43% of FY23 revenue): A fuel card functions similarly to a debit/credit card but is restricted to fuel and vehicle-related purchases such as parking, maintenance, and tolls. They are superior to traditional corporate cards because of the negotiated discounts at specific gas stations, spending controls (restrict purchases to fuel-only, specific stations, gallon limits), detailed reporting and automated reconciliation. CPAY offers both proprietary fuel cards (closed-loop) and universal cards (on MA’s rails). The proprietary card offers more control features and better discounts, but with a lower acceptance rate (55k gas station vs. 175k for the universal card). For most companies a regional network is sufficient as the average SMB customer only uses two gas stations. For drivers that travel a lot across states, the universal card is the better option, hence why CPAY offers both. Gas stations benefit from joining CPAY's network due to the volume it brings and the potential for high margin inside sales. In their core market, the US, they enjoy a duopoly with WEX. Their products are relatively similar, but CPAY skews more towards small to middle-sized fleets where fuel card penetration is lower (40-60%). Conversion to fuel cards is gradual, with about a 1% increase in penetration annually. Internationally (40% of CPAY business), penetration rates are significantly lower due to some oil majors still owning the retail network and promoting their own cards. Revenue is split roughly 1/3 equally between interchange fees (~2% of the transaction price on the universal cards), fuel price-spread revenue (pay wholesale and receive retail gas price within their proprietary network) and fuel card, reporting, white-label and late fees. This is an MSD+ growth business driven by new customer wins and revenue per transaction (rising retail gas prices over time and card fees increases).

Tolls (10% of revenue): CPAY owns the leading Brazilian toll business (the world’s #2 toll market), which collects 90% of all electronic toll payments. Initially a toll tag business (a bar code that you stick on your windshield to drive and pay through tolls without waiting lines), CPAY expanded the offering to facilitate parking, gas/charging stations, car washes, insurance, and even drive-through payments (partnered a.o. with Arcos Dorados). They also launched the Sem Parar Mobility app, used by >3m people. In FY23, 35% of revenue came from non-toll products. This is a subscription model, selling over 7 million toll tags at $5 per month. Current penetration is in the low- to mid-teens, compared to >25% in France and Germany. Since CPAY’s acquisition of this business in 2016, it is growing revenue organically in the low teens.

Lodging (14% of revenue): Targeting blue collar workers (mainly fuel card customers), airlines (when there are delays or flight cancellations), and insurance policyholders (temporary housing for disaster victims). They have partnerships with over 40k hotels in the US, booking nearly 40 million rooms annually (or 1/10 the size of ABNB). This scale allows them to negotiate steep discounts of up to 50% with the lowest prices for 9 out of 10 hotels. They pass most of the savings on to their customers and keep a spread for themselves ($14 of revenue per night booked). The business is very similar to the fuel card, only instead of a network of fuel merchants it’s a network of hotels/motels. Both are B2B closed-loop network businesses with discounts and control features (works only for specific purchases at specific locations with customizable spending limits). All lodging receipts are automatically reconciled and integrated to the client’s accounting system. Growth is a function of selling more room nights and a higher revenue per night booked (rising ADRs and negotiating better discounts). Organic growth over the past six years averaged >10%, which includes the impact of Covid.

Other (7% of revenue): Pre-paid gift and payroll cards in both plastic and digital form. These are non-core, that’s why management bucketed this under “Other” after last year’s re-segmentation. They were looking to sell these assets but couldn’t find the right price. I wouldn’t be surprised if this gets sold in the future.

Corporate payments

The segment consists of two parts: cross-border payments and domestic accounts payable (AP). The former generates about two-thirds of the segment's revenue, while domestic AP accounts for the remaining third. Both focus on middle-market (MM) companies ($5m-$1bn in annual revenue).

Cross-border

CPAY is the largest non-bank FX provider, managing $110bn in FX flows for 21k clients. About 60-70% of cross-border revenues come from automated spot payments, typically for recurring transactions like accounts payable, rent and salaries. Think of import/export companies that purchase/sell goods overseas or US firms that pay their EU-based employees. The remaining 30-40% comes from risk management and hedging services, where they advise CFOs/treasures (most MM companies don’t have the expertise in-house). For example, whether and how to lock in an FX rate when buying a foreign company six months from now. CPAY automatically reconciles all transactions into the client’s accounting/ERP system. CPAY earns an interchange on each transaction with a higher fee for risk management/hedging.

CPAY primarily competes with banks that dominate 90-95% of the market, mainly focusing on large clients and underserving the smaller ones. Since CPAY targets the MM they often compete with Tier 2 banks. CPAY’s service is superior with a broader payments network, better tech and more FX specialists. This enabled CPAY to take share, as evident by their 20% annual organic revenue growth. There is limited competition outside of banks. Convera (previously Western Union Business Solutions) is the number two with $500m in FY22 revenue (vs. $800m PF FY23 revenue for CPAY). From there the scale drops quickly with UK-listed peers Alpha Group and Argentex that only do £110m and £49m in revenue respectively. Wise also competes here but is mainly focused on B2C remittance. Either way, I don’t think this will be a winner takes all market, very few are. Importantly, they mainly compete with banks with over 95% of customer wins coming from them.

The B2B cross-border payments market faces limited competition from scaled operators due to regulatory license requirements and the need for a global banking network. If you want to move money in or out a jurisdiction, you need a license. In the US, each state requires a separate money transmitter license. In Europe you need to have Payment Institution and Electronic Money Institution licenses. Not only is it hard to obtain these licenses (regulators are cautious in granting them), but it can also take up to a year if you are lucky enough to get one. Even CPAY had to wait a year to get an Irish license. Once you have the license, you need to keep up with all the capital, KYC, AML and other regulatory requirements that constantly change. You need scale to do this profitably. CPAY’s main rationale of past acquisitions in this space is to obtain licenses in new markets. With limited players of scale left, new entrants need to build this from scratch. This is hard to replicate and explains why banks even as large as BofA come to CPAY to help them process payments in jurisdictions where they don’t have the license. The second barrier comes from having a large network of banking relationships. CPAY has developed the largest network among non-bank providers and second only to two or three banks. CPAY can facilitate payments in 200 countries in over 140 currencies. Over the span of two decades, they cobbled together a network of local in-country liquidity providers and FX banks that they trade with. Over 60% of the FX flows are netted within CPAY’s network, reducing the FX fees for clients significantly.

Domestic AP

This segment focuses exclusively on the US. Around 70-80% of revenue is derived from virtual cards and full AP (accounts payable software). Here, CPAY earns its revenues from interchange on the payments they process and a software fee. The remainder comes from the channel business (granting other parties access to their virtual card merchant network).

Two decades ago, accounts payable (AP) relied entirely on paper checks. Today, about 50% of payments in the US are electronically, mainly via outdated ACH system, which still requires significant manual work. Virtual cards are the next step in AP payments, offering greater automation and fraud protection. A virtual card is a digital, often single-use 16-digit card number used for transactions. Linked to a main credit or debit account, virtual cards are tokenized, turning sensitive data into unique identifiers, reducing vulnerability to fraud. Other benefits include spending controls (customizable spending limits and expiration dates), automated administration (not the case with both paper checks and ACH) and faster transactions (suppliers receive money faster and buyers can benefit from early pay discounts). Uses cases include all kinds of B2B payments on invoice (e.g. a construction company buying wood from a vendor, an auto dealer buying parts from an OEM etc.). Adoption is gradual as suppliers can accept checks for free but must pay a processing fee for accepting virtual cards. Indirectly, this is more than offset by faster payments as well as more data such as remittance data which improves the efficiency of the reconciliation. CPAYs primary competition in virtual cards are checks and ACH. CPAY is the largest non-bank virtual card issuer and the 7th largest overall in terms of spending volumes. However, they are the largest virtual card issuer in terms of cards and have the largest acceptance network (>1m merchants), more than twice the size of the number two (JPM). This network is important as acceptance needs to be build out merchant by merchant, which CPAY has been doing for over two decades. Virtual cards are winning share from the other payment modalities and CPAY with the largest network should be a key beneficiary of this trend.

Full AP is a service where clients outsource their AP processes to CPAY. From capture of the invoice, continuing through the approval and review stages and ending with the payment of the invoice. CPAY naturally push their own virtual card, but can also facilitate payments by check, ACH, and cross-border. CPAY and peer AvidXchange (AVDX) estimate that clients can cut their AP department by three and save 60-70% in costs by outsourcing their AP.

CPAY mainly competes with manual AP workflows, as 70% of MM companies haven’t automated their AP yet. Most AP software targets either large enterprises (which use expensive solutions like SAP, Oracle, and Coupa) or SMBs (which use simple one-size-fits-all solutions like QuickBooks that recently ended its partnership with BILL). MM companies are too small for the cost-prohibitive enterprise solutions and too complicated for a simple SMB solution. More than half of MM companies use vertical specific ERP systems (e.g. auto dealers with CDK). This is why CPAY and its main peer, AVDX, follow a vertical strategy. Each focus on a handful of verticals, build domain expertise, integrate with the most important accounting/ERP systems and then use these providers as referral partners. Once you reach a certain scale within a vertical, it’s hard to be dislodged as customers are very sticky (>95% retention rates) and ERP providers are not willing to work with small start-ups as it can ruin the customer experience. Moreover, they will continue to push the AP software of their most dominant partner.

AVDX is the largest player, but CPAY is not far behind with each holding less than 2% share. They don’t really compete with another as AVDX mainly focuses on real estate and HOAs (>60% of their revenue) and CPAY is strong in construction, automotive, healthcare, hospitality and education verticals. Coupa focuses on large enterprises and BILL on SMBs. There are also some private players, the largest of them being Tipalti ($110m in annual revenue). Competition will probably heat up over time, but by then CPAY likely has a scale and network advantage. Importantly, competitive threats seem to be far away given the outsourcing opportunity, with AVDX stating that 95% of customer wins are first-time outsourcers.

CPAY’s advantage is that they have the payment capabilities with the largest virtual card merchant network and the cross-border business. Both AVDX and BILL need to pay CPAY for access to their virtual card network. A good chunk of US-based MM companies also does business abroad, and CPAY is the only player that can offer a bundle of both domestic and cross-border payments. Another advantage is that CPAY can grow inorganically. Scale within a vertical is key. For example, the Paymerang acquisition announced in Q1, gave them inroads to new verticals with access to 1.3k customers, 100+ accounting/ERP integrations and 25+ referral partnerships. Both AVDX and BILL have been loss-making on a GAAP earnings and FCF basis (after SBC) and thus limited in their ability to grow inorganically.

The corporate payments segment has more moving parts than CPAY’s other segments. The business has some barriers to entry, but the competitive dynamics are certainly not set in stone. We do need to give the management team some credit as they have demonstrated to know how to build and scale strong network effect businesses. They really build a well-oiled sales machine. I am sure that two decades ago, the future of the fuel card business faced some competitive uncertainties as well. Finally, both businesses have large tailwinds (picking up underserved customers from banks, the move from checks/ACH to virtual cards and from manual work to automation). All are still in early innings. This is a business with 40% GAAP EBIT margins, capital light, growing ~20% per year organically with mid-to-high 90s% retention rates, where you don't have to pay for high expectations. Management believes they can continue to grow organically at 20%. Even if competition heats up soon and growth slows down to only MSD, then it still seems good value to me at a >7% FCF yield.

Valuation

CPAY guides for 10% organic revenue growth and 15-20% EPS growth. Excluding Covid, the company has hit these targets in every three-year period. With the faster growing corporate payments segment becoming a larger part of the business, it’s likely that they will grow faster than in prior years. At the current price you have a 7-8% NTM FCF yield. Add to that a conservative MSD organic growth assumption (historically 9-10%), some margin expansion and balance sheet leverage and you are already at mid-teens growth. If they continue to grow revenue organically at 9-10%, the upper end of their range is achievable, likely leading to a re-rating towards historical levels and a >20% multi-year IRR.

Capital allocation has been excellent. They have closed around 100 deals over the past two decades. Unlike many companies in the payment space, CPAY doesn’t bother with sales multiples. They want to do deals that are accretive immediately or next year. They have a track record of doubling profits over the following two to four years (cross-selling, better sales force, cutting duplicative tech, staff and other shared functions). It’s not often that you see large consolidators with an after-tax ROIC (incl. intangibles) of 23%. Even highly regarded consolidators like TMO, DHR and ICE only have a ROIC between 8-10%. Management also opportunistically repurchases its shares. They increased their buybacks in 2018 when the share price fell, slowed down in 2019 as it rebounded and upped again in the years thereafter when the share price continued to be pressured. In 2022 alone, they repurchased 7.5% of their shares and another 5% YTD.

Risks

EV Risk. The biggest overhang on the shares according to CPAY and WEX. I think this is way overblown. First, EVs account for less than 1% of US commercial vehicles. It will take at least a decade before it reaches any meaningful penetration. Second, both companies actually believe EV adoption will be a tailwind. WEX for instance, offers a $5 per vehicle per month subscription for access to charging stations (80% coverage), integrating utility billing and home charging reimbursement features. This is through an app instead of a fuel card, on which drivers can see all the charging stations, whether they have fast charging, current availability and more. Some of these services are add-ons to the base subscription, hence >$5 per vehicle per month. Which compares to ~$6 they earn on average on ICE vehicles. In the UK, CPAY reports that EVs carry even better economics with EV’s representing 32% of the cards and 40% of revenue. Moreover, it will shift the business from fuel sensitive transactional to subscription-based revenues.

Increased competition in the corporate payments segment. The payments space is complex and dynamic with new players seeming to pop up out of nowhere. There is a good chance I overlooked some competitors. I do think there are some barriers in CPAY’s market that will make it more difficult for new players to enter than in other parts of the industry. The market opportunity is very large in both cross-border and AP with nearly all the growth comes from share gains from banks and the shift from check/manual to digital. Even if competition heats up, it will probably take a while before they start to compete heavily with one another. Also CPAY is not a legacy incumbent like FSV, rather they are going after the incumbents. Lastly, the businesses are very sticky. If they can’t reach 20% organic growth, but rather only grow with existing clients, it’s not hard to pencil LSD-MSD growth, which albeit disappointing, not a huge downside risk at the current valuation.

Key man risk. Ron Clarke led this company since 2000 and was instrumental in turning it from a $20m revenue and cash burning business into $4bn revenue with >50% EBITDA margins. He still owns 5% of the shares (incl. options). At the age of 68, it’s a question of how long he will stay on. His stepping down would surely be a negative. Steve Green, President of Corporate Development and Strategy, seems the most logical successor. He has been with the company since 2009 and is responsible for M&A and strategy.