Fair Isaac: I Am Still Hold Rated As The Valuation Multiple Is Too High

seekingalpha11-19 20:52

I maintain a hold rating on FICO due to its stretched valuation, despite strong fundamentals and robust growth in Scores and Software segments.Fair Isaac's Q4 revenue grew 16.4% y/y, driven by 27.4% ...

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I remain hold-rated for the stock as I still think it is hard to assume FICO will continue to trade at such a high valuation multiple (70x forward earnings). While the growth story is intact, if FICO were to miss expectations, the stock price could plummet. Investment thesis On 06-11-24, FICO released its 4Q24 earnings, which saw revenue of $453.8 million, an increase of 16.4% y/y, above consensus of 14.9%. By segments, Scores revenue grew 27.4% y/y to $249.2 million, driven primarily by 38% y/y growth in the B2B channel. Within this B2B channel, mortgage originations revenue grew 95% y/y, auto originations revenue declined 2%, and card & personal loan originations revenue fell 5%. Software revenue grew 5.4% y/y to $204.6 million, split between $181.7 million from on-premise and SaaS software and $22.9 million from professional services. In terms of operating margins, Scores EBIT margin expanded by 20 bps y/y, while software EBIT margin contracted by 20 bps y/y. Collectively, inclusive of unallocated corporate expenses, adj EBITA expanded by 100bps to 52.3%, bringing total adj EBITA to $237.3 million and EPS to $6.54, which beat consensus estimate of $6.36. The FICO growth story remains very much intact, and there is multiple evidence to support this. For one, scores revenue growth accelerated significantly both sequentially and annually, by 780 bps and 1510 bps, respectively, driven by accelerating mortgage revenue growth from 80% to 95%. The underlying strength stemmed from a positive inflection in mortgage volumes in 4Q24 and the substantial step-up in mortgage pricing increases. The questions here are: (1) whether mortgage volume will continue to spike up; and (2) can FICO sustain this pricing and/or raise it even higher. I believe the answer to both questions is yes. Regarding volume, it should follow the fed rate movement over time, which the Feds have signaled to continue cutting rates, albeit a more gradual process. Also, the increase in housing inventory should improve housing affordability as supply catches up. As for pricing, I think there is still a lot of headroom for FICO to raise prices (if they want to). For reference, despite FICO announcing the cost of a mortgage score to be $4.95 in 2025 (note this is a big pricing tailwind as it is up 42% from $3.50 in 2024), which will represent around 15% of the tri-merge bundle cost (typically costs $80-100, as per 4Q24 call), the FICO score's share of total closing costs is just 0.2% (average mortgage closing costs of $5-6,000). Aside from mortgages, FICO Software revenue growth remains very robust as well. In 4Q24, software platform ARR (annual recurring revenue) grew 31% y/y, which was consistent with 3Q24 and 2Q24. Given that management observed ongoing financial institution adoption of FICO platform offerings and that monetization remains robust under a consumption-based revenue model, I think this ~30% ARR growth is a baseline to think about FICO's software revenue growth. Given that less than half of the world's 300 largest banks use FICO's platform and that the company is still in its early stages of expanding its platform business, I think the growth runway is long, especially if we consider that FICO can sell the platform to smaller banks and other verticals. With all the above discussed, I think there is a good chance that FICO beat its FY25 revenue guidance. As a reference, management FY25 guidance calls for total revenue growth of 15% and EPS growth of 20%. Firstly, the FICO management team has historically been conservative on their revenue guidance (typically beats the midpoint by 1.3% over the past 10 years). Secondly, the substantial increase in mortgage score pricing and the potential for a strong recovery in mortgage volume should easily push growth to >15% (since 4Q24 already grew at 16.4% y/y). Note that management only partially incorporates Scores special pricing increases for the FY25 guide. Naturally, if revenue beats, given the low fixed cost nature of the business, I'd say EPS will grow faster than expected too. Valuation Own calculation As much as I like to turn bullish on FICO stock, I simply cannot stomach the valuation (73x forward PE) that FICO trades at today (I know I have made this mistake multiple times, as the stock price keeps rallying). Looking at my previous models, a mistake that I made was modeling one year out (probably too shortsighted in hindsight). As such, for this model, I modeled FICO earnings potential in FY27, assuming that growth continues to accelerate on the back of better pricing and higher mortgage volumes, coupled with margin expansion (similar pace as the guided FY25 vs. FY24). Using these assumptions, FICO should generate ~$1.1 billion in earnings in FY27. Even if I attach a 50x forward PE multiple (the peak of COVID multiple and recent high, pre-the recent rally), it would only translate to a share price of $2,239. Although one could argue that multiple can continue to stay at 73x forward earnings (it did go from 40x to 50x to the current 70x), I do not have confidence that it will sustain at this level; as such, I remain hold-rated. Bloomberg Risk Consumer credit conditions continue to be soft with rising delinquency rates across cards, personal loans, and autos, and lenders are adopting a conservative stance with credit originations. Given the low level of consumer confidence, this may result in a headwind to FICO revenue and earnings growth. Margins may contract by more than expected if FICO steps up in investing in its software segment, where it is building out its sales force, developing the platform, and absorbing both legacy server and cloud computing costs. Conclusion  In conclusion, my rating for FICO is a hold rating. While FICO continues to show strong fundamentals, driven by robust growth in Scores and Software segments, its current valuation remains significantly elevated. Despite the potential for continued growth, the high forward PE multiple of 70x makes it challenging to justify a bullish stance. If FICO were to miss expectations, there is a high risk of a potential price correction. As such, I maintain a hold rating on FICO.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.2","shortVersion":"4.29.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2484945040"}