Corpay, Inc. (CPAY) Earnings Call Transcript & Summary

All right. Welcome to the 2023 Ray J TMT and Consumer Conference. My name is John Davis. I'm the lead payments and fintech analyst here at Ray J . We're excited to have FLEETCOR CFO, Tom Panther, with us this morning. So first, welcome, Tom. Thanks for coming.

Great to be here. Thanks, JD.

So we're going to treat this as a fireside chat. If there's questions in the room, feel free to raise your hand, and we'll try to keep this as interactive as possible. So Tom, you've been on the job about 9 months or so now. Maybe first impressions, why FLEETCOR, you hopped into a strategic review, sale of Russia. What surprised you? Just kind of early thoughts?

Sure. Yes. No, it's been a busy 8 to 9 months. That's for sure. We've been doing a lot over the last period of time. JD, as you said, we sold the Russia business. We looked at selling the prepaid business. We've been doing a variety of integration efforts related to some of the recent acquisitions we acquired PayByPhone in September. And then obviously, we've been doing a lot related to strategy. And strategy is not something that is new to FLEETCOR. They've involved in strategy and M&A type activity as part of their DNA. But where you have a strategic review occur that's provoked by some activist activity, then that takes it up to another decimal level. And so we've been doing a lot related to the strategic review, which for me, in terms of onboarding has been a great opportunity to just learn access to all types of opportunities to gain more information about the company. What I would say in terms of what's surprised me or from an impression standpoint when you think about our businesses, you think of FLEETCOR as having a lot of complicated businesses. And that's true. But I've been surprised by the relatedness of those businesses, how the products that are associated with the fleet business versus the lodging business versus the corporate payments business. are so related and then a little bit of how we -- I'm sure we'll get into this a little bit of how the strategy in Brazil and how we've been able to take a single product and build an ecosystem of products around it is also a related strategy that we're now deploying as well. So all of that kind of fits together as opposed to something that just looks like three stand-alone silos.

Okay. And I know the strategic review, we're kind of in the late innings here. Maybe just a quick update, a little history lesson of kind of what you guys looked at. Clearly, now it's more of some sort of like spin merge, outright sale or have any asset, but maybe just kind of give a quick update there.

Yes. Yes. Well, just to kind of quickly conclude and close the loop on what we've decided versus what is still pending. And from a decide standpoint, at least as of now, we all live in businesses that are living and breathing organisms, so things can always change. But looked at whether or not the sale of a segment made any sense. No, look at whether or not a pure tax-free spin made any sense. No, I can explain a little bit why if people are interested. What remains is a bit of the hanging Chad that we're still looking at is whether or not a merger type transaction with a strategic partner makes sense. And you say, "Well, why would you look at that?" Well, I would say tax and dilution avoidance. We can obviously look -- we look at transactions all the time. We're strategically minded company. We've done almost 100 acquisitions over our 20-plus career. If we were to do this, it would be a structure that would allow us to minimize any type of tax or dilution impact. And that would be what we would look at. I think of kind of a JV-type structure underneath the holding company with potentially some type of liquidity event in the future as you bring that company in, work on synergies, top and bottom line, that would be the type of thing that we would -- that we continue to explore. Ron has used the dance partner metaphor the dance card has gotten narrower, much fewer names. We looked at a variety of things over the course of the review. One of the things that the Board said, when this got kicked off is we want to be extremely thorough. We don't want to come back and have to revisit this. We want to be able to demonstrate to our shareholders that we looked at everything. And so we've been extremely thorough in terms of all the different permutations. But I think where we stand now is just a handful of dance partners. And our expectation is that we'll be able to conclude this in time, include this in terms of what's the next step? Are we pursuing something yes or no. Certainly not close anything by our February earnings release. But certainly, we would be able to be a point where we'd say, "okay, we've completed all of our analysis and this is what we've decided." Now strategy and M&A is always going to be part of what we do. And so that's not to say no matter what the outcome is that we're not going to pursue something at a later date. But I think it's important to be able to bring this to a head. I guess the last point I'd make is that it's not some pay to complete that we're definitely doing something. It's a very high bar approach, very analytical in terms of how we think about this. And so if we did do something, it would be something that we thought had not just a lot of strategic value, but it also had financial merit as well. We commented that if we're looking at a particular segment, it was related to corporate payments. I think the thing I would leave you with as we think about corporate payments across multiple types of subsegments. This isn't an all or nothing kind of thing. In fact, I don't think you could find another corporate payments business that has the products and geographies that we do from multi-car to virtual card to full AP across border. So if we were to do something, it would be related to something that would potentially augment a segment, a subsegment of that larger segment versus something that you sit there and say is a complete cousin to what we have today because like I said, I don't think there is a cause into what we have today.

That's very helpful. And then maybe switching gears. You mentioned on the third quarter call that you were going to reshuffle the reporting segments from five into three. So maybe just talk a little bit about the thought process of trying that.

Yes. It really is in keeping with simplification. A lot of the feedback that we hear, both internally, but more importantly, especially for this audience, externally is around simplification. And so essentially leaving lodging and corporate payments as they are, but bringing Brazil and fleet together into vehicle payments, is a little bit in terms of what I was talking about earlier, J.D., in terms of the relatedness. The strategies, the products, what we're trying to do with those businesses is quite similar. The geographies are different. And maybe some of the anchor products are a little bit different, I think toll tag versus parking versus fuel, but we see them coming together as a business that has that secret sauce of large customer base and large proprietary networks, bringing those together gives us an opportunity to strategically talk about that business holistically. Now for you investors, I know information is something that you hold very dear. And so while we will report a consolidated segment, you'll still continue to get the Geo breakdown, that's one of the things that we'll have to do from an SEC reporting standpoint. And we were just meeting internally just last week in terms of what KPIs look like so that people can understand some of the KPIs within the vehicle payments business so that you can maybe distinguish what's going on in a parking environment where the transactions are completely different in terms of frequency versus a tag tolling environment versus fleet environment. But the reality is this is all starting to get a bit cross-pollinated because we have so many multiproduct customers now. In Brazil, we've referenced 60% of our consumer customers are multiproduct. They started as a simple user a toll tag and now they're using three, four, five, six products that we're able to sell to them, predominantly through digital means of an app. And even in the U.K., one of the things that we were -- have made advancements on is almost 30% of our sales now in the U.K. are nonfuel-related sales. So that's an example of customers and networks being a real success measure where we can go to those customers, 1 million-some-odd drivers in the U.K. and be able to introduce them to where we have a network that expands to 20-plus charging station, 60-plus percent coverage. Expose them to repairs and service and maintenance and tires where we have a network of 40,000 garages. So we can take 1 million drivers made up of 60 so customers -- 60-some-odd thousand customers, and be able to show them these other networks and be able to help them with their overall fleet management. So all of that is about the strategy of starting to cross-pollinate and bring all of this together because we see a real proof point starting in Brazil but emerging also in the U.K., and we think also will be a game changer in the U.S. where we can bring together these customers and these networks and bring multiple products in front of them, generally deliver through a phone. Which what better way to deliver all of this is through a mechanism that you and I are all used to using every day of our lives, fortunately or unfortunately, depending on your point of view. But at least from an economic standpoint, it's a very easy, frictionless, relatively low-cost way for us to develop tech some UI that allows us to slap products over the course -- over the face of that phone that somebody is already used to using.

Okay. That's helpful. Maybe turning to quarter-to-date trends in the fourth quarter. I think the guide implies about 10% organic growth similar to the third quarter, but just curious, you called out some lodging softness. Ron said macro was a little bit weaker than you expected in the third quarter. So just curious on any update quarter date.

Yes. Sure. I mean I think in a business like ours, the trend tends to be what it is. The thing about this business is it's quite recurring. It's a base. It moves like a barge, not a speedboat, sometimes the analogy I use. And so I think that trend is what we see here as we sit here in December. We did see a little bit of those signs at some level of macro softness. I mean it's not surprising. I mean, companies regardless of whether they're in Brazil or the U.S. or the U.K. they've withstood a fair amount of inflation. They withstood a fair amount of wage increase. Interest rates up in most of those markets, Brazil, not so much they had already started to cut some rates. They're in a different cycle. So sure, a little bit of some level of softening, but more within pockets of our business. And one of the things that's great about the size and scale and geography of FLEETCOR is, we're diversify and resilient enough to be able to withstand those. But in some of those pockets of the business, we'll feel those. We think they're cyclical, not structural. We've talked to customers to validate our thesis. But that comes with the ebbs and flows, particularly when you're in this economic potential inflection point. I think all of us would agree, at least as we think about the U.S. and the U.K., which we probably know better than how you think about Brazil is the fact that the U.S. economy, U.K. economy, European economy as a whole has been stronger in 2023 than I think all of us were necessarily being told what happened a year ago. And so I think that's continued. That's broad macro. One of the things that sometimes clarify a little bit is our nomenclature maybe gets in our way a little bit because we also think internally macro. We use the term macro inside our company all the time. And we're not necessarily talking about big picture macro about economies and GDPs and spend levels. We're thinking about fuel cost and FX, kind of those more narrower, more technical levels of macro spreads as it relates to fuel a very complex way in which we earn money in a portion of our fleet business. That [indiscernible] macro in particular, was a little softer in the third quarter than we had anticipated. We saw a rapid run-up in fuel price, oil, et cetera, and then it dropped. And so we've seen some spread normalization as we exited the third quarter. But those elements of macro, the more technical level are things that were a little bit of a headwind in the third quarter.

Okay. Great. And that's a great transition to kind of the '24 framework that you laid out, the 9% to 11%. You kind of touched on it a little bit there, but explaining kind of what you mean when you're saying neutral or slightly positive from a macro perspective. I think that's important.

Well, that their -- in those words about neutral to positive, it was more of our internal language, the more technical side where we saw fuel and FX as positive. We saw interest rates as positive. We saw bad debt. So the point of that commentary on the earnings call, we really weren't making news about the top line, given a range of 9% to 11%. That's our midterm guide. When you think about the nature and durability of our business, I think that's where people would expect us to be. That's where we expect to be. We're going through the planning process. We'll tighten that up clearly in our February call as we finalize things. But the real point of that conversation was the massive headwinds overhangs that the company was staring into or even experiencing a year ago, third quarter and fourth quarter, interest rates were up significantly. We were heavily weighted variable rate debt balance sheet that we've tightened up some we're now 60% fixed rate. We put on some pretty attractive swaps where we have some positive carry on those. Bad debt has gotten significantly better I would say that the exit rate of bad debt today is about where we expect bad debt to be. Maybe dollars go up because spend goes up. But on a basis point level, we would expect bad debt to be where it is. Taxes feel about where we would expect them to be. You can imagine with the number of legal entities that we have in the number of jurisdictions. There's all kinds of tax planning things that we're constantly working on. Some of them are tax jurisdictions trying to earn more revenue and taking benefits away from us, so we got to plan and find another planning opportunity in other jurisdictions. So taxes feel about in that 27% kind of effective tax rate range. FX, if anything, it feels like with the Fed taking a pause that the dollar will continue to weaken and the FX will be a benefit to that, call it, 40% of our business that's international. So there's more technical, what we were referring to as more of those technical elements of macro. Felt like they were neutral and the broader economy felt stable to us. It's kind of how we think about that. We're not betting on a big macro tailwind at either the broad level or the technical level to be at our back to be able to do that 9% to 11% number.

Okay. And then I know you have disclosed or kind of given thoughts on segment level yet, given you're still in the planning process. But as we think about the fleet segment or corporate payments, any call-outs on why wouldn't kind of be in that normal range of outcomes?

It's a momentum-based business. made this comment before in some of our breakouts. If you think about us, just to use round numbers, a $4 billion business. We're not solving for $4 billion every year. We're solving for the increment, if you want to use 10% as a number the math simple, we're solving for that $400 million incremental revenue that we're making every year. And so as we think about just the various businesses that we have, the portfolio of businesses, what we think their growth rates are, those big large momentum-based businesses that have recurring customer bases, recurring users, what's nice about it, it's a nice ratable business. It just kind of runs and we're managing it to try to get the incremental growth off of that. I think you can expect growth trends to be pretty consistent. I don't see a massive pivot in terms of the growth rates, plus or minus a couple of percentage points on either side.

Okay. And then as we shift to the fleet segment, the new vehicle segment would kind of be a high single-digit normalized grower, you have aspirations to get to potentially low double digits in Brazil plus the current fleet business. So maybe just talk about some of the initiatives that could potentially get you over that hump into double-digit going forward.

Yes. But just in terms of sheer math and again, we're more about strategy and not math, but just kind of level set us on the map. When you bring Brazil in with the fleet business and combine the vehicle Payments segment, you have kind of an 8% grower, just to use a number, obviously, plus or minus based on where we are. That's, call it, 50% of the company, plus/minus. We see the opportunity of that business. One, the core business is just to continue to grow with their trend line, whether it's the U.S. fleet business, the international fleet business or Brazil. But what we're bringing into the strategy that's particularly exciting that we think adds 2% to 4% kind of growth rates on top of that 8% number. I think we referenced a 10% to 12% range by the time we get to 2027 is what. I was talking about before, bringing together customers and networks where we already have large customer bases and on the B2B side and proprietary networks that we don't think can be replicated in terms of vehicle usage services that our customers would use. So just by adding that on to the B2B side, we think can add back to the increment comment, another $200 million, $300 million to the revenue base. Then on the consumer side, a market that we really haven't been in at all, except for in Brazil, but by buying PayByPhone in September, we essentially acquired both. That was kind of a [ 2 for ] where we not only did we get a network of over 1,300 parking operators but we also got a customer base of 6 million active users. Those 6 million active users are distributed across the U.K. at about 2.5 million. The U.S. at about 2 million, and Europe is about 1.5 million. So that's 6 million of active users that every day or give or take, at least once a month, are on their phone paying for parking. Now we're interested in parking in and of itself, yes. But really what we're interested in, again, back to the strategy, is a customer race in the network. Because why? Because we've got 6 million active users who are using that phone, and we can then relatively easily from a tech investment standpoint, introduce those customers to multiple products and turn them into what we have in Brazil, where I said earlier, 60% of our customers are using multiple products. We can take somebody who's used to using PayByPhone only and start showing them insurance, EV, fuel repairs and maintenance -- I knew I had another one. I was missing it, repairs and maintenance, all of those things where we can just make them a multiproduct user. That then brings an opportunity for, call it, another $200 million to $300 million of incremental revenue. So when you take the existing businesses that have demonstrated durable growth rates at their trend line, coupled with the entry into these cross-sell opportunities, that defines what the vehicle payment ecosystem looks like. That's how you get to a 10%, 12% grower. So at that point, you've got a business that's growing 10%, 12%, 50% of the business just on a relative side, assume they were growing at the same rate. Corporate payments, which is, call it, 25% of the business by then, it would be larger, growing at high teens and then lodging, growing in the low to mid-teens. We think that's a pretty impressive business and one with margins that are 50-plus percent margins, we're exiting this year at a margin around 54%. So we think that's a business that certainly relative to our current EBITDA multiple should garner a fair amount of capital interest.

No, that's great. And then just touching on the margins, given you have such high EBITDA margins, how should we think about the operating leverage in the business. Obviously, I think fuel or fleet rather is your highest margin segment, growing the slowest. So just you have a little bit of a mix shift headwind. How should we think about margins over medium term.

Yes. I mean, the beauty of this business is it's not capital intensive, and it's fairly fixed cost. And so once you get to scale, when you think about fleet, you think about lodging, they've been around for a long time, those businesses have gotten to scale. You just get the structural benefit of revenue growing faster than expenses. It's just the beauty of the way the businesses are structured. And then on the corporate payment side, which you saw is a pretty interesting step up in margins there. It's getting to that level of scale where buying GRG earlier in the year on the reach on the cross-border side added a significant amount of business opportunity to against a fixed cost platform. We're actually able to extract efficiencies from the prior company that we acquired just because we are all on one platform. So even though there's a little bit of a mix shift of those businesses, maybe with a little bit higher margin growing faster, we still see margins next year and beyond in that mid-50 range. I mean at some level, that the margins can't go to 100% nor do we necessarily want them to. We want to continue to invest in the business for the long haul. We're very methodical and disciplined around the variable costs, namely the sales and marketing that we spend. We think we've seen a multiple years of kind of a test and learn of what works, what doesn't work. what type of marketing has returns to it, namely salespeople. Yes, some branding and advertising. But when you're predominantly a B2B shop, our advertising is more to kind of get name recognition out there. We're not big into advertising that tends to work more in a retail-based organization. And so I think the marketing dollars, marketing that we spend is more around client acquisition and business or origination that's real kind of tangible where you can actually see the spend and the return, which as a finance guy, I particularly like.

Yes. No, that makes sense. And then obviously, given kind of the uncertain macro backdrop, there has been focus on your bad debt expense, I think it was only 6 or 7 basis points last quarter. How should we think about you tighten credit? What kind of top line impact has there been -- just as we think about, obviously, bad debt or what's the right level? Is it is 6 or 7 or should it be 10% to 15%? Like how do you guys think about bad debt and kind of growth in that trajectory.

Yes. we think about bad debt and more in a way, we want to take some risk. But relative to, say, a financial institution completely pales in comparison. So bad debt generally is around how do we minimize it because we want to be fairly restrictive with respect to how we think about credit. The credit that we offer is a revolving type credit. We didn't really know when somebody is going to pay us within 2 weeks to 30 days just in terms of how our payment terms roll. So we would say as I mentioned earlier, where we see bad debt now is a bit kind of in our sweet spot of where we like it to be. We have seen -- because we lost the revenue, namely some late fees and some card fees and some level of fuel-related revenue. We did see some revenue impact and revenue erosion associated with significantly reducing our exposure to those micro SMB segment. EBITDA positive but revenue erosion. But we're more focused on making sure that we go after customers they are going to stay with us, that are going to repay us back and that we have a nice, steady recurring revenue flow. And the micro segment, kind of a digital-only go-to-market strategy was a bit of an experiment that we decided to test and learn to move away from. We're not getting away from digital. We still spend marketing dollars on digital forms of interaction. But we supplement that now with field, much like the way we go to market in the U.K. and in Australia, where you've got a combo of warming them up with digital, introducing them to content with digital, but then having field representatives who are experiencing our products being able to kind of further cultivate the relationship and close the sale.

Okay. No, that's helpful. Maybe switching over to Corporate Payments, which has clearly been a bright spot this year, 20% growth. Maybe just talk about the different -- how we think about corporate payments seems a lot of things different people. You have an FX business accounts payable business virtual card, channel partners. Maybe talk about how you get that 20% maybe by channel or segment, how do you guys think about it internally?

Yes. Well, the reality is when you think about it in its 2 big pieces, a payables business and a cross-border business. they're both growing at similar clips. And the diversification of that business has been a particular strength of ours, whether it's the product diversification JV that you mentioned in terms of the full suite of products that we can offer from a basic T&E card all the way up to full AP to a cross-border to multiple geographies. Our cross-border business basically never sleeps. It has a trading desk in Sydney and in London and in Toronto. So it's constantly on the move, both the traders as well as the salespeople. So that's kind of an interesting concept where you literally have a business that's up and running 24/7 or maybe not the 7, but at least the 24. Although some of those guys do continue to cultivate relationships and call on CFOs and treasurers even on the weekends to try to close an FX trade. But we see the businesses really is just having extremely strong sales capabilities. All of those things, the products that we've been able to create have been able to give us the ability to sell at extremely high levels. I think both of them are right in the high 20s this past quarter. Cross-border had been outperforming that a little bit a couple of quarters in a row because we were mining that global reach portfolio that we had recently acquired. So that gave us an opportunity to really kind of go to a whole new customer base and introduce new products and services to them. But the real secret sauce of that business is the base continues to naturally grow because more and more spend comes across our rails as they gain a greater degree of awareness of what we can offer. The attrition is next to nothing. These are very sticky customers. They are large customers. So the bankruptcy and out of business rate is quite low. 70% of our business is over $20 million in revenue. Almost 30% of the business is over $1 billion in revenue. So these are large, chunky customers. are they immune to economic ebbs and flows? No. No company is. But the diversification of the business allows us to work in a way that allows us to kind of continue to put up those kinds of numbers. Every quarter is a new quarter. So we'll -- we obviously are always paying attention to what's going on within our customer base. But we feel really good with what we've put together from a geographic and from a product standpoint. That the business has really got a lot going forward and has a lot of moats to protect itself.

Okay. Great. We have about a minute or so left. If there's any questions in the audience. All right. Well, I'll wrap with one more. Just on M&A, balance sheet is in good shape. I think leverage about 2.7x. Can we expect more stuff on the consumer side? Is that kind of a is that was pay by phone, you wanted the network and the consumer just kind of came with it? Or just curious kind of where M&A priority.

I don't think you'd see a lot of capital deployment on the consumer side. Again, if there was another interesting asset out there, particularly like the template to PayByPhone, where you got both network and the way of the parking operators as well as consumers, all within the vehicle ecosystem, great. We're always looking at things that would maybe be attractive on the corporate payment side. We see that as a business that if it's 25% today, we want it to continue to get bigger, not just because it's growing the fastest, but because we're doing some things inorganically. So I think the M&A environment, I think '24 is set up for a nice M&A environment. Obviously, it takes to do any of those things. But I think valuations are generally coming down. Private companies, I think, are a little bit hungrier in terms of a liquidation event. Our balance sheet is in extremely good position. We generate -- this year, we'll generate almost $1.4 billion in free cash flow. That just creates cash flow in and of itself. And then we have strong access to capital, whether it's stuff right off of our revolver or the ability to do additional things. I don't see us doing anything in terms of issuing equity. If anything, we'll be buying equity back. We still think at a $2.50 stock price, buyback is still part of our deployment strategy. But it's going to be a mix. We believe that using our capital for recurring earnings on the M&A front is important and probably would be the first place we would go but we also think buying FLEETCOR in a buyback arrangement is also a really attractive investment too. And we've got the high-class problem of generating well over $1 billion of free cash flow every year. And so we have the opportunity to say, well, what do we want to do with that? And it's make more money.

All right. Well, thanks, Tom, I'll wrap it after there.

Good. Thanks, JD. Thanks, everyone.