Equifax (NYSE: EFX): A Bull Case Theory

Equifax (NYSE: EFX) is a global information services firm offering credit reporting, income and employment verification, as well as risk assessment services to financial companies, businesses, government institutions, and individual consumers. Originally named Retail Credit Company, Equifax boasts proprietary databases of consumer and business information, including utility payment and telephone data, wealth data from brokerages, rental and property information, criminal justice records, credit history, education, and historical income and employment records stored in The Work Number (TWN) database, which it acquired in 2007. The company operates in three segments, namely Workforce Solutions, which accounts for 44% of sales, followed by US Information Solutions (USIS) at 33% and the remaining from EFX’s international operations. EFX leverages these datasets and its analytics prowess to enable consumers to make well-informed credit decisions regarding loans and employment. Meanwhile, institutions use EFX’s credit reports to determine credit eligibility, verify identities, as well as monitor and reduce fraud. Despite global operations, EFX generates over 75% of revenue from US markets. While the company’s core business has been credit reporting, competing primarily against Experian and TransUnion, EFX is being increasingly recognized for its TWN database of income and employment records, which is utilized by mortgage providers and recruitment teams to instantaneously authenticate the work details of potential consumers and employees. Here, we summarized a bullish March-end thesis published by Jumbos02 on Value Investors Club.

The company has showcased steady growth due to several intrinsic factors, including growing consumer credit over time. However, the rapid adoption of the TWN database by screeners and lenders in recent years improved market penetration significantly. The TWN business now makes up 80% of the Workforce Solutions segment and has helped bump profit margins to almost 56% from around 21% in 2008, with ample scope for securing a higher market share. EFX is also nearing the close of a $1.5 billion investment cycle to upgrade its IT systems and cybersecurity measures to migrate all data to the cloud securely. Management expects revenues entirely originating from cloud operation to touch 90% by year-end. The ongoing transition has already enhanced security, sped up product innovation, and lowered operational overheads, which will normalize capex and improve free cash flows (FCF). EFX’s significant exposure to the mortgage market hasn’t fared well for the company in recent years amid the US Fed’s historic monetary tightening campaign. Mortgage inquiries have generally accounted for almost 20% of company revenues, which jumped to 32% during the 2021 homebuying surge before nosediving by over 80% to 18% of total sales. Looking ahead, the setup could prove lucrative as further downside is limited, and EFX would win big if mortgage rates come down. Management believes a return to 2015-2019 mortgage activity levels could translate to an additional $1.1 billion in revenues, an EBITDA of $700 million, and an almost $4 in EPS. The company trades at mid-30s multiples of forward earnings, but the company could reach its long-term, mid-teens earnings growth target on the back of steady TWN market penetration, pricing, and a rebound in the mortgage market. EFX’s mortgage revenue could also benefit from FHFA’s new upcoming credit score requirements for loans sold to Fannie and Freddie. The development will lead mortgage lenders to require reports from only two credit bureaus rather than all three bureaus, in addition to mandating that providers must also use VantageScore (VS) alongside FICO scores for risk assessments. FICO stated it doesn’t see any revenue impact, which could mean it is planning to price up to offset the decline in FICO score inquiries for mortgages. The same applies to VS. In turn, credit bureaus will pass the price jump to end users. While EFX could lose 33% of its volumes, given its massive mortgage exposure, the expected average rise in pricing to justify the FICO’s price hikes alongside VS would offset the volume-related headwind.

EFX expanded globally, including Europe and South America, in the 90s via acquisitions while simultaneously enhancing analytics capabilities and databases for better lending outcomes. The company continues to bolster its presence in South America with the latest takeover of the nation’s top credit bureau, Bos Vista Servicos. The USIS segment witnessed revenues and adjusted EBITDA growth at 5% and 4% CAGR, respectively. Adjusted EBITDA margins were above 40% in 2015, before EFX’s 2017 data breach that massively increased its security and systems upgrade expenses. Margins remain impacted due to the mortgage activity slump, but the company in 2021 revealed a roadmap to grow the USIS segment between 6% and 8% organically using AI and cloud-native data infrastructure for product R&D. Meanwhile, top US enterprises contribute records directly to the TWN database, which had 166 million active records by 2023 end, with most of them being exclusive to TWN. The 2021 Apriss Insights acquisition also bolstered the company records database growth of 12% CAGR with the addition of 770 million court records, further enhancing its background check offerings. Workforce Solutions revenues and adjusted EBITDA improved at a 16% and 18% CAGR, respectively, since 2011, likely prompting management to forecast 13%-15% revenue growth during its 2021 Investor Day. The division is poised for growth as record count increases to drive a higher “hit rate” in tandem with more companies contributing records to the TWN database, resulting in higher market penetration. In the past five years, solid pricing, especially in mortgage and background screening, has also played a key role in supporting overall revenues.

EFX could double its FCF in 2024 to over $1 billion and grow at an almost 20% rate through 2029, possibly delivering between 13% and 18% IRR, including dividends, from here onwards. EFX’s Verification Services segment makes up nearly 80% of Workforce Solutions revenues and is also positioned for growth from the accelerating adoption of the TWN database. The growth of records addition to its databases could pick up as management is open to partnering with smaller payroll providers and storing records like pensions and those related to the gig economy. The fragmented background screener market also offers a window for EFX to capitalize by recruiting smaller firms. EFX has higher pricing power in segments that pass on costs to end customers, like mortgages, than in verticals that don’t, like government partnerships. The company has markedly accelerated new product R&D innovation, which is supported by its transition to the cloud. Its innovation index, which measures the proportion of revenues from products launched in the last three years, has increased to almost 14% annually from 5%-7% pre-cloud. EFX also reduced capex by over $200 million in 2023 and expects to lower overheads further by another $65 million this year. The ongoing cloud transition is expected to save the company on tech spending by almost 15%, supporting margin growth moving forward. However, EFX faces several risk factors, such as sustained weakness in the mortgage market, regulatory concerns, and rising competition in the background verification segment. While competition threats don’t look like a major concern right now despite Experian expanding its database, some rivals are using consumer permissioned data (CPD) that can bypass TWN’s exclusive contract with payroll providers and employers. EFX is well placed to grow its non-mortgage verification services as the TWN business takes shape. Management expects to exit 2024 with net leverage of almost 2.5X compared to 3.2X in Q1 with the view that the 2.5X level is adequate to retain BBB credit ratings, enabling it to hike dividends and repurchase $1 billion in stock annually as earnings grow. Even then, EFX would retain over $2 billion in excess capital for any potential M&As.

EFX is not on our list of the 31 Most Popular Stocks Among Hedge Funds. As per our database, 38 hedge fund portfolios held EFX at the end of the second quarter, which was 40 in the previous quarter. While we acknowledge the potential of EFX as an investment, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is as promising as EFX but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.

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Disclosure: This article was originally published at Insider Monkey.