One industry that may have unique insight into the current state of the consumer are companies that provide back-office or underlying technology services to banks and merchants. The leader in that field is Fidelity National Information Services Inc. (FIS, Financial), which recently gave investors some insight into the state of the economy. Unfortunately, it was not great and, as a result, the stock suffered a steep one-day decline.
Also known as FIS, the company provides advanced technology solutions for merchants, banks and capital markets firms worldwide. It operates through three distinct segments. The first, Merchant Solutions, provides enterprise and small business payment processing solutions as well e-commerce solutions to online retailers. The Banking Solutions segment provides core processing and ancillary applications such as digital banking, fraud, risk management and compliance solutions. The Capital Market Solutions segment offers securities processing, global trading, asset management, insurance and corporate liquidity solutions.
Founded in 1968, Fidelity National currently has a market capitalization of $35 billion.
Industry update
The current macroeconomic climate has created some challenges for the company as it is seeing what it called a “broader economic slowdown,” In the banking segment, it has observed longer sales cycles for large deals (over $50 million) as banks become cautious with their spending, even though the pipeline remains strong. In the merchant segment, the company mentioned it has detected early signs of domestic consumer shifting spending habits from discretionary to nondiscretionary verticals, which pressures its margins. The U.K. represents about 15% of merchant segment revenue and the company indicated spending slowdowns there as well. In the capital markets segment, the macroeconomic environment was not as impacted.
Financial review
On Nov. 3, the company released third-quarter results that were somewhat disappointing. Organic revenue increased 5% to $3.6 billion, while the adjusted Ebitda decreased 1% to $1.57 billion. The Ebitda margin decreased to 43.7% from 45.2% compared to the year-ago quarter. Net earnings also decreased 1% to $1.05 billion compared to $1.07 billion the prior-year period. The banking and merchant segments both showed operating margin contraction while the capital markets segment was able to increase margins.
In a statement, outgoing Chairman and CEO Gary Norcross commented on Fidelity National's performance.
“Despite deteriorating macroeconomic conditions, FIS delivered third quarter revenue and earnings in-line with its prior outlook. We are taking actions to ensure the company is well positioned to drive profitable growth as we continue to face an uncertain macroenvironment," he said.
The company generated free cash flow of $684 million during the quarter, paid $284 million in dividends and repurchased shares totaling approximately $1 billion. Unfortunately, these share repurchases were made at much higher prices as the stock plummeted 25% after the earnings release.
The balance sheet carries a lot of debt, which totaled $18.9 billion at quarter-end. The company has made many acquisitions throughout its history, which were mostly financed by debt. The leverage ratio is a still reasonable at 2.9 and the average interest rate is only 2%.
Valuation
The company lowered its 2022 guidance to $14.5 billion in revenue, $6.2 billion in adjusted Ebitda and earnings per share of $6.63. The primary culprits were the macroeconomic environment, inflationary pressures and sales execution. That puts Fidelity's stock selling at 9 times the current year's earnings. The enterprise value/Ebitda ratio is also approximately 9 due to the high levels of debt on the balance sheet.
The GuruFocus discounted cash flow calculator creates a value of approximately $90 using $6.63 in earnings per share as the starting point and a long-term growth rate of 6%. Using the reverse DCF model, the current stock price implies almost no future growth in earnings.
The company is committed to paying a strong dividend with goals of an over 20% annual dividend growth rate and a payout ratio of approximately 35%. The current annualized dividend is $1.88, which creates a dividend yield of 3.12%. Based on 2022 earnings estimates, the payout ratio is 28%, leaving room for upside based on the company’s 35% payout ratio target.
Guru trades
Gurus who have purchased Fidelity National stock recently include Robert Olstein (Trades, Portfolio), Steven Cohen (Trades, Portfolio) and Ken Fisher (Trades, Portfolio), while those who have reduced or sold out of their positions include Paul Tudor Jones (Trades, Portfolio), Louis Moore Bacon (Trades, Portfolio) and Keeley-Teton Advisors, LLC (Trades, Portfolio).
Conclusion
Fidelity National Information Services can often be an economic bellwether due to its end market customer base of banks and merchants. The company is seeing a slowdown along those lines, both domestically and in international markets. However, after a 60% decline from 2021 highs, that bad news may be priced in to the stock.
The company is also undergoing a CEO transition with Stephanie Ferris starting on Jan. 1, 2023, which may bring new strategic leadership and growth.
Fidelity National ppears to be undervalued based on most metrics and the above-market dividend yield may provide some base stability. For long-term investors, this may be an attractive entry point and there appears to be a decent margin of safety.
