2 FinTech companies with room to grow

It has been a turbulent year so far for many reasons. Interest rate increases and fears of a global recession have weighed on the markets. Companies whose valuations are heavily based on how much their earnings are expected to grow will feel the effects more than others.

When interest rates rise, the value of expected future earnings falls. In that environment, as we’ve seen this year, high-growth companies tend to suffer.

At the same time, fears of a slowdown in the global economy mean investors have moved away from these investments, putting pressure on companies trading at higher prices.

This means that many high-growth companies have seen their valuations fall. But not all are created equal, and there are still opportunities for investors.

The financial technology (FinTech) space sits very much in the growth aisle. There is no hard and fast definition of a FinTech business, but they typically look to innovate and disrupt traditional methods of finance by using new technology. We’ve looked at a couple below.

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Shopify

Shopify may have started as a pure commerce play. But it has made inroads into the payments and fintech space as it looks to expand the range of services it offers customers.

Mainly aimed at small and medium-sized businesses, Shopify offers a one-stop shop for running a commerce business. Sellers can use the cloud-based service to build and customize an online store, while other services allow payments across a variety of channels, such as online to brick-and-mortar locations.

Once you sign up, Shopify offers a variety of upgrades and add-ons to help businesses customize and grow. These additions have become the main driver of revenue for the business.

And therein lies one of the group’s most important competitive advantages. Once you are entrenched in the system, it is very difficult to get out. That has helped revenue grow at an annual rate of 62% a year since 2017. The group took over 10% of US e-commerce sales in the US last year, second only to Amazon.

Chart showing Shopify revenue ($m)

Source: Shopify Investor Overview Deck Q2 2022.

Positioned at the heart of the growing e-commerce revolution has kept the group in good stead. But it hasn’t all been ordinary.

The group expanded its business in recent years, preparing for a major shift in spending away from in-store retail. To some extent, that has happened, but it hasn’t been on the scale Shopify had hoped.

Coupled with a changing global environment, that has put pressure on smaller businesses as capital costs rise and consumer spending comes under pressure, and the group’s valuation has fallen this year.

Lack of earnings expectations in the last two quarters has not helped either, and the outlook for growth for the whole year has taken a hit along the way.

In response, the group cut 10% of staff and plans to slow down new hires. It is never good to hear that there is a need for staff cuts, but decisive measures now should help to make operations more efficient later.

Profits are under pressure this year, and the group is expected to have an operating loss of around 160 million dollars for the whole year. Although the strength of the balance sheet means that the group has the firepower to continue investing in growth despite a challenging period in the short term. Net cash on the balance sheet is around $6 billion.

For investors willing to accept some short-term volatility, Shopify’s solid relationships with businesses and exposure to long-term trends are attractive. Especially considering that the group trades at a price to sales ratio of 7.6, well below the long-term average.

But there is no doubt that the valuation still needs fantastic growth. The next year or two will be difficult as e-commerce trends shift back to more normal growth rates and consumer spending comes under pressure.

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Intuit

Intuit’s product line includes some names you may have heard of, such as QuickBooks, TurboTax, and Credit Karma. These services leverage technology and artificial intelligence to help individuals and small businesses manage their finances and taxes.

Central to the case is Intuit’s business-critical software and services – as the late Benjamin Franklin famously pointed out, taxes are one of life’s certainties.

That means demand could remain sticky long into the future. Intuit has an impressive history of leveraging this to drive sales that have grown at an annual rate of 17% over the past 5 years. Q3 2022 revenue grew 35%, with full-year growth expected to be between 31-32%, which could be around $12.7 billion.

Last year’s acquisition of Mailchimp, which cost around $12 billion in total, was a sign that Intuit is keen to expand its addressable market. It’s already having an impact, with about 6 percentage points of revenue growth in the third quarter coming from the newly acquired business.

Mailchimp is a digital marketing platform for small and medium-sized businesses and is expected to add more than $30 billion to the group’s addressable market, which totals $300 billion. Apart from a larger market, there are genuine cross-selling opportunities with QuickBooks so that businesses can market their company and manage finances seamlessly.

The software-based model means that profits are of a high quality, leading the group to have an operating margin of more than 30% consistently over the past few years. Profit flows seamlessly through to cash and analysts expect free cash flow of $3.9 billion for the full year. If we compare that to expected cash earnings (EBITDA) of $4.8 billion, that’s a cash conversion of over 80%.

Chart showing Intuit’s operating margin

Source: Refinitiv Eikon 18.08.22 (figures for 2022 and 2023 based on analyst estimates)

Looking at the balance sheet, debt has increased due to the Mailchimp acquisition, and net debt at last count is $3.3 billion. It will be a cash burden over the next few years if the group wants to bring it back down. That could put some pressure on the modest 0.6% prospective dividend, but more likely by returning excess cash via buybacks if cash flows fail. The group spent 1.3 billion dollars on share buybacks in the first three quarters of the year. Remember that no return is guaranteed.

Given the upside, it’s not surprising that Intuit typically trades at high price-to-earnings ratios. At the end of last year, it reached 60 times expected earnings. This has put the business well in the firing line as interest rates have risen and investors have looked to more value-based investments in 2022.

As a result, the valuation has come down from the peaks to sit at 34.6 times expected earnings. It is still above the long-term average and offers more potential than it has in a few years, but requires consistently high growth to justify it.

See the latest Intuit stock price and how to trade

Unless otherwise stated, estimates are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Past results are not a guide to the future. Investments rise and fall in value so investors can make losses.

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