Fair Isaac Corp.: Way Above Fair Value (NYSE:FICO)

Table of Contents

Introduction

Almost everyone that has made a large purchase on credit knows Fair Isaac Corporation (FICO), by exposure to the FICO credit score. But Fair Isaac does much more than provide a credit score number to the car salesman. In fact, the company makes many products that enable various businesses to make better business decisions. Fair Isaac was founded in 1956 on the premise that, when used intelligently, data can improve business decisions. Thus, leading the company to create many mathematical algorithms to predict consumer behavior were packaged into applications, services, and software.

Fair Isaac operates in three segments, Applications, Scores, and Decision Management Software. The company offers products ranging from credit scores to fraud solutions to decision-making tools. Fair Isaac Corp. has a stable and growing product line, but to invest in the company, you’ll have to pay for a lofty valuation. As a value and growth at the right price investor, I am kicking myself for missing the March low of $177 but I’m staying out of the company for now.

Historical Financials

FICO FinancialsFair Issac Segment BreakdownFICO MarginsSource: SEC 10-Ks

Over the past five years, Fair Isaac has seen great revenue growth. The CAGR for revenues over the period was 6.71%. As can be seen, operating revenue and net income also had great growth, with both posting CAGRs of 12.98% and 17.15%.

The Applications segment is the largest, producing 52% of revenues and offers industry-tailored decision-making applications such as the FICO Marketing Suite, FICO Fraud Prediction, and more. The Scores segment makes up 36% of revenue and provides scores that provide consistent/objective credit risk. The main product of the Scores segment is the FICO Scores product that many banks, lenders, and credit organizations use across the U.S. The Decision Management Software segment offers on-premise analytic decision-making tools for businesses such as the FICO Decision Management Suite.

The second graph shows that revenue growth has been coming from all segments. In particular, Scores has seen high growth over the five years. In 2019, Scores revenue grew 25% and in 2018 grew 29%! To go along with this, Applications grew 7% in 2019, while Decision Management Software grew 34%. The growth in Scores is great news, as this segment has the highest operating margin of the bunch at 86%! Applications and Decision Management Software have operating margins of 27% and -26%, respectively. Fair Isaac has made a push to move product offerings from on-premise to cloud-based. Cloud-based products are being applied to Applications and Decision Management Software and should help boost margins in the future. As of 2019, 39% of all bookings were for cloud-based products.

In the third graph are Fair Isaac’s margins over time. What can be seen is the other factor that has added to the bottom line. As a percent of revenue, the cost of revenue and SG&A have decreased from around 31% and 37% to 29% and 36% in 2019. Fair Isaac Corp. focused on gaining revenue from recurring cloud-based products. This approach costs less than an on-premise-focused model and has contributed to the lower-cost margins. The results of this strong revenue growth and lower costs have been a large bump in operating and net margins.

2020 Financials and Outlook

Everything was great in 2019, but 2020 offers a much different business landscape. With three quarters in the books, Fair Isaac has not seen any large effects from COVID-19. In the first quarter, the company had revenue growth of 14%. This was followed up by 11% growth in quarter two and a flat quarter three, combining for a nine-month total growth rate of 8%. Breaking down the nine-month growth shows that Scores was again the major gainer. Scores revenue grew 23%, while Decision Management Software grew 17%, and Applications declined 5%.

For the nine months, the cost of revenue and SG&A as a percent of revenue continued to decline to 29% and 34%. Operating income increased by 15%, and net income increased by 29% compared to last year. Total bookings so far have been down from last year at 302 million compared to 321 million. So far, Fair Isaac has earned $5.92 per share for the common stockholder. As can be seen by the above results, there have not been any disruptions from the pandemic.

Financial Health

Looking at the most recent quarter, balance sheet, Fair Isaac Corp. has a current ratio of 1.05x and a debt-to-equity of 5.33x. The current ratio is good and shows solid liquidity. The debt to equity is okay and is manageable with a times interest earned in 2019 of 6.38x. Overall, these metrics are fine as the company is not experiencing any stress from the pandemic. Fair Isaac also has historically good returns on assets and invested capital. The 10-year average ROA and ROIC are 8.76% and 12.65%.

Valuation

Fair Isaac Corp. is currently trading at $426 per share. My conservative 2020 EPS forecast is $7.74, therefore, the company trades at a P/E of 55.04x. With a book value per share of $8.25, Fair Isaac also trades at a P/B of 51.63x. Fair Isaac Corp. does offer stable and growing top and bottom lines, but the PEG using a conservative growth rate of 23% is high at 2.39x.

Conclusion

Fair Isaac Corp. is a business that has a great core product line that is growing. Revenue growth over the past five years has been at a 6.71% clip, while net income has grown at 17.15%. The main growth driver has been the Scores segment, which boasts prior-year revenue growth of 25% and operating margins of 86%. With the company moving toward cloud-based applications and software, costs should decrease over time. Fair Isaac has not seen any negative effects from COVID-19, and the business should succeed in the long term. With that being said, the valuation is lofty. This is my first time taking a deeper dive into the company, and I am disappointed I missed the March low of $177. Overall, I am looking for value and growth at the right price, which I do not think Fair Isaac Corp. offers at the moment.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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