The Bull Case For Fair Isaac Corporation

With Quiver Quantitative’s recent institutional holdings data, we can see that hedge funds and asset managers have been increasing their holdings in Fair Isaac Corporation FICO. Firms such as Fidelity, T. Rowe Price, and Nuveen Asset Management have all recently added to their FICO positions. Most notably, Fidelity increased shares held by 72.76% (as filed on 9/30), bringing their total FICO holdings to 87,527 shares worth nearly $100 million dollars at current market prices. With this in mind, we took a closer look at some of the reasons why many investors may be bullish on Fair Isaac Corporation. 

In November, Fair Isaac Corporation announced strong earnings results for the fourth quarter of FY23. Net income in the quarter sat at $101.4 million dollars, up from $90.7 million dollars in Q4 of FY22, implying a 11.8% YoY increase. Additionally, EPS for the quarter was $4.01/share, up from $3.55/share in Q4 of FY22, implying a 13% YoY increase. In terms of revenue, revenue came in at $389.7 million dollars in the quarter, up from $348.7 million dollars in Q4 of FY22, implying a 11.8% YoY increase. As we can see, Fair Isaac Corporation has shown impressive top and bottom line growth in revenues and net income, signifying the business’ increased operational efficiency over the last year. Management guided FY24 revenues at $1.675 billion dollars, FY24 net income (GAAP) at $490 million dollars, and FY24 EPS (GAAP) at $19.45/share, implying YoY increases of 10.7%, 14.2%, and 13.2%, respectively. With these positive earnings results in mind, we took a closer look at some of the reasons why many investors may be bullish on Fair Isaac Corporation.

Fair Isaac Corporation is a leading applied analytics company. The business was founded in 1956 as a business data analytics company, and today FICO’s software and widely used FICO Score operationalize analytics, enabling thousands of businesses in over 100 countries to identify new opportunities and make timely decisions that matter at scale. Most credit card issuers and leading banks rely on Fair Isaac’s business solutions, along with telecommunications providers, automobile lenders, consumer reporting agencies, insurers, retailers, public agencies, and organizations in other industries. Fair Isaac Corporation consists of two operating segments, Scores and Software. The software segment includes pre-configured analytic and decision management solutions designed for a specific type of business need or process, such as account origination, customer engagement, marketing, fraud protection, customer management. Additionally, this segment includes FICO Platform, a modular software offering designed to support advanced analytic and decision use cases, along with stand-alone analytic and decision making software that can be configured by customers for custom use cases. The business’ Score segment includes B2B scoring solutions and services, giving their clients access to predictive credit and other scores that can be easily integrated into their transaction streams and decision making processes. The Score segment also includes B2C scoring solutions.

The market for Fair Isaac Corporation’s solutions is intensely competitive and constantly changing. Management acknowledges that they encounter competition from several sources, which include fraud solution providers, scoring model builders, providers of credit reports and credit scores, in-house analytic and systems developers, and business intelligence solutions providers, among others. Management believes that the principal competitive factors affecting their markets include technical performance, product attributes (scalability, adaptability, interoperability, etc.), product price, customer service and support, reputation, and existing market penetration. Fair Isaac’s solutions compete favorably in these competitive factors, leading to sticky products that allow for the business to enjoy easily predictable top-line revenue generation and growth.

Fair Isaac Corporation’s management is solid, and their capital allocation priorities do a good job of creating shareholder value and aligning shareholder and management interests. Management likes to repurchase shares to return excess value to shareholders. During FY22, management repurchased $1.1 billion dollars worth of common shares, with an additional $407 million dollars worth of repurchases in FY23. Not only does this show management’s strong capital allocation priorities, it shows how efficient they are as well. During FY23, Fair Isaac Corporation’s stock skyrocketed, meaning that shareholder value from stock repurchases decreased. Therefore, they slashed repurchases to focus on putting cash towards initiatives that benefited the business, showcasing management’s efficiency when it comes to capital allocation. While management likes to repurchase shares to return value to shareholders, they don’t offer a cash dividend on common stock (since 2017), and there are currently no plans to offer one in the future.

In terms of management incentives, management is incentivized well, with a compensation structure that does a good job of aligning shareholder and management interests. The compensation structure includes a base salary, short-term cash incentives, and long-term equity incentives. The annual cash incentive incentivizes management to meet predetermined financial metric goals, allowing the business to meet its financial and growth goals, much to the benefit of shareholders. Additionally, the long-term incentive rewards (paid out via stock options) retain executive talent over the long-term, while also allowing management to build equity in the business. This further incentives management to improve the business’ operating results, further benefiting shareholders and aligning shareholder and management interests.

Fair Isaac Corporation is an efficient business. The business currently operates at a LTM ROIC of 52.8%, along with a LTM EBIT (operating income) margin of 42.3% and a LTM gross margin of 79.4%. With the business currently operating at a WACC of 9.6% (Source: Factset), Fair Isaac Corporation currently operates with an ROIC to WACC ratio of 5.5x. This is a good sign as an investor, as this ratio indicates that Fair Isaac Corporation is able to generate returns in excess of its cost of capital, meaning that Fair Isaac Corporation is efficiently using this capital to generate profits. Additionally, the margin profile of the business is stellar, with LTM EBIT margins of 42.3% and LTM gross margins of 79.4%, as mentioned above. This means Fair Isaac Corporation is able to generate significant operating income (EBIT) and gross profit from its revenue, a positive sign as gross margins and EBIT margins expand, alongside healthy top-line revenue growth. In fact, Fair Isaac Corporation operated at an EBIT margin of 21.1% in 2014, compared to today where the business operates at a LTM EBIT margin of 42.3%, very healthy margin expansion over the last decade that shows the business’ increased efficiency in managing operating expenses and generating profit from its core business activities.

Analyzing Fair Isaac Corporation’s income statement, we can see some stellar sustained growth in revenue, gross profit, and earnings within the last decade. In terms of revenue, Fair Isaac Corporation has grown revenue at a CAGR of 6.73% since 2014, with no YoY revenue drawdowns in that time period, showcasing the business’ sticky products. In terms of gross profit, Fair Isaac Corporation has grown gross profit as a CAGR of 8.34% in that same time period. This growth in gross profit can largely be attributed to expanding gross margins. In 2014, the business operated at a gross margin of 68.4%, compared to today where the business operates at a gross margin of 79.4%. In terms of earnings, Fair Isaac Corporation has grown EBITDA at a CAGR of 12.7% since 2014, with EPS growing at a CAGR of 19.9% in that same time period. This growth in EPS can largely be attributed to share buybacks. Since 2014, Fair Isaac Corporation’s shares outstanding have decreased by 23%, handsomely rewarding shareholders in the process (Fair Isaac’s share price has increased at a 34.1% CAGR in the last 10 years).

Looking at Fair Isaac Corporation’s balance sheet, we can see that the business operates in sound financial health. The business currently has around $136.8 million dollars of cash on the balance sheet, paired with around $1.8 billion dollars worth of long-term debt on the balance sheet, leading to a net debt of around $1.765 billion dollars. While this low cash to long-term debt ratio may be a red flag for investors, we don’t believe that it should be a cause for concern. Looking at Fair Isaac’s most recent 10-Q, the business currently operates with around $182 million dollars of positive net working capital, showing that the business has more than enough liquid assets to cover its short-term obligations. Additionally, with an interest coverage ratio of 6.71x (which signifies that the business generates $6.71 worth of EBIT for every dollar of interest expense that the business incurs), Fair Isaac Corporation has plenty of runway to cover its debt obligations.

Analyzing Fair Isaac Corporation’s cash flow statement, we can see some stellar sustained growth in net income and free cash flow within the last decade, showcasing the business’ increased operational efficiency. Since 2014, Fair Isaac Corporation has grown net income at a CAGR of 16.3%, with free cash flow growing at a CAGR of 11% in that same time frame. This growth in free cash flow can largely be attributed to expanding free cash flow margins. In 2014, Fair Isaac Corporation operated with a free cash flow margin of 20.6%, compared to today where the business operates at a LTM free cash flow margin of 30.3%. This free cash flow margin expansion, along with mid-single digit top-line revenue growth, allows for Fair Isaac Corporation to generate more and more free cash flow. This increased cash flow can be used to expand the business (as we have already seen, they are able to generate very healthy returns from their cost of capital, evidenced by the business’ ROIC to WACC ratio), pay down debt, or pay / increase dividends to shareholders.

After conducting a reverse discounted cash flow analysis, we can see that current share prices imply a 24.15% growth rate (CAGR) in free cash flow over the next 10 years. Essentially, the market expects free cash flows to grow at a CAGR of 24.15% over the next 10 years, based on current share prices. While we believe Fair Isaac Corporation is an extremely high-quality business, we believe that this valuation is overvalued, and we would encourage investors to find a better price to enter a position in this wonderful business. With free cash flow growing at a CAGR of 11% within the last decade, we highly doubt that the business will be able to double that growth during the next decade, despite steady top-line revenue growth and expanding free cash flow margins. Again, we believe that it is advisable to wait for a better price to enter into a position in Fair Isaac Corporation, as it is a high quality business that is trading at a very high valuation (and remember, high quality businesses usually trade at a premium as high future growth expectations are priced into the share price). This valuation is entirely based on our proprietary models, and we encourage all investors to do their own due diligence to arrive at their own valuation, which may lead to another viewpoint on the business contrary to ours.

Keep an eye out for FICO stock’s latest news, data, and more with Quiver Quantitative. 

This article is from an external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.