Paymentus: Expect Stable And Normalized Growth Trend Ahead To Push Stock Price Up

Summary

Paymentus (NYSE:PAY) develops cloud-based bill payment technology and solutions. I am recommending a buy rating as PAY performance is much better than expected, and the underlying execution has certainly negated the bear thesis that was prevalent in FY22. With the business stabilizing and going back to its historical growth rate, I believe the outlook is much clearer now. The market should gradually gain confidence in PAY's outlook as it continues to grow at a mid-20% rate, thereby driving the stock price up.

Financials / Valuation

PAY reported 2Q23 gross revenue of $149 million and adjusted gross profit of $50 million, which are all above consensus estimates by 6% and 6%, respectively. With the beat in revenue and gross profit, PAY also beat consensus estimates on the EBIT level by a large percentage ($4.6 million vs. expected $0.4 million).

Based on my view of the business, PAY should be able to grow at 25% in the near term, just as it has for the past few years, as the business sees normalizing and stable trends. Multiples should stay at 2.2x, in line with peers (such as Bill Holdings, Flywire Corp., EngageSmart, AvidXchange, and ACI Worldwide) that are trading at an average of 2.3x forward revenue, just as they did historically.

Comments

A great 2Q23 performance from PAY. The 2Q23 results were significantly better than consensus estimates, especially in terms of profitability. Consensus was effectively pricing in breakeven-like profitability, but PAY came in much ahead. This should force consensus to upgrade their profit estimates significantly. I would also point out that spreads have tightened back to historical levels, driving an improvement in contribution margins. Recall from 1Q23 that contribution margin (% of gross revenue) fell to 35% but has now recovered back to the 40% range. This is definitely a sign of stabilization and should ease investors’ concerns about future compression. More importantly, the stabilization of the top line growth (at the 20+% range) suggests that PAY is not facing a significant slowdown in implementations, which many other enterprise-facing software companies are experiencing.

In fact, PAY appears to be performing better than expected, with implementation times decreasing year over year. In addition, the fact that PAY was able to successfully increase prices with its billers, mitigating the effect of the price hikes, is further evidence of the PAY's solution stickiness and effectiveness. Assuming that PAY's price hikes are sustainable, but transaction costs are reduced, this could be good news for profit margins.

We are encouraged by the results of our repricing actions with the customers, as well as other cost-reduction initiatives we have undertaken. Source: 2Q23 earnings

Although PAY's 24% revenue growth lagged behind that of its competitors like EngageSmart (ESMT) by a modest amount, I believe that the company's strong backlog, better-than-expected implementation cycles, and positive repricing traction make up for this.

This drove robust bookings, enabling us to exit the quarter with a substantial backlog. Based on our strong quarterly performance and the positive business trends Dushyant mentioned earlier, and our expectations for the remainder of 2023, we are raising our full-year 2023 revenue contribution profit and adjusted EBITDA guidance, which I'll talk about shortly. Source: 2Q23 earnings

In terms of the stock movement cadence, I expect positive reaction from the 2Q23 results as it represents a strong turnaround from FY22 narrative. Remember that in the fiscal year 2022, PAY faced a challenging period during which bears predicted a reduction in contribution margins due to (1) elevated energy costs in the previous year, (2) delayed passing on the impact of increased energy costs to consumer electricity prices, and (3) PAY's transaction-based pricing model that doesn't gain from this surge. The bears were also worried about additional implementation delays. The 2Q23 results effectively debunk the bear thesis for FY22 due to increased contribution margins and quicker implementation speed. As a result, I have a more sanguine view of the outlook, anticipating declining inflation and more typical implementation cycles. In addition, profit margins could further improve due to deflationary effects in its utilities business line, and the PAY's revenue growth may accelerate in 2024 thanks to its expanding backlog.

Management's increased confidence in revising upward the FY23 guidance aligns with my positive perspective. Management now forecasts a revenue range for FY23 at $599 million to $609 million, compared to the previous estimate of $591 million to $606 million, with a midpoint increase of $5.5 million and a high-end adjustment of $3 million. Notably, the projected FY23 contribution margin outlook has been elevated to a range of $231 million to $238 million from the earlier $225 million to $237 million, with the midpoint seeing a $3.5 million boost. Given the enhanced visibility in bookings, backlog, and implementations, I anticipate that the consensus will readily incorporate this updated guidance into their projections.

Risk & conclusion

The landscape of electronic bill payment solutions comprises established legacy providers, contemporary biller direct platforms like PAY, aggregator platforms, banks, Mastercard, in-house, and niche solution providers. Should more well-funded rivals enhance their capabilities to bridge the solution gap, it could pose a risk to PAY's standing in the industry.

All in all, I advocate a buy rating for PAY, underpinned by its robust performance and the successful execution that countered FY22's concerns. With PAY's stability restored and its historical growth rate resumed, the outlook appears clearer. As the company sustains a mid-20% growth rate, market confidence should gradually strengthen, ultimately driving the stock price upward. Stabilized contribution margins, decreased implementation times, and successful biller price increases bolster PAY's position. The recent upward revision of FY23 guidance further reinforces my positive outlook.