WEX: Fleet Cards - [Business Breakdowns, EP.131]

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0:45This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. This is Matt Russell, and today we are breaking down a big fish in a less known pond. That is WEX. WEX is a leader in the fleet card market. And to put it simply, they offer trucking businesses special credit cards, which help secure advantage rates on fuel, among many other things. Now, this is a business with a long history. WEX is headquartered in Maine, and they really came to life in the 1980s. To break down WEX, I'm joined by Mark Tomasovich from Energize Capital, multiple -time guest on Business Breakdowns.

1:27We get into the history of this industry and how WEX found a very creative way to accelerate adoption within this market. Without further ado, please enjoy this breakdown of WEX. All right, Mark, welcome back, our first third -time guest on Business Breakdowns. So we'll be getting your memorabilia in the mail shortly. But we aren't covering a traditional energy name today. I would say it's a little bit more on the infrastructure side of energy, a little bit tangential. So maybe you could just start off with a quick overview of who WEX is and what WEX does. So WEX's core product is a fleet card.

2:08And when you think about a fleet card, what that is, is it's a credit card that fleet operators can use for buying fuel. So everyone from your delivery truck driver all the way to the vehicle that your plumber uses for driving around to various homes, they all buy their fuel from your local retail gas stations. And with a fleet card, they can access certain negotiated prices, and then the fleet operator can actually manage spends. So I definitely want to get into the background here and how this business came to be because it's a very interesting niche. But I thought we could actually start off with the addressable market and whether we break that down by overall gasoline market, fuel market, or specific to fleets, however you think is best to do that.

2:54How would you categorize and size up the market that they operate in? When you look at the whole U .S. motor gasoline market, the U .S. is consuming 400 million gallons of motor gasoline per day. And then when you look on the fleet side, there's about 40 million fleet vehicles in the U .S. Like I said earlier, that's everything from your Amazon vans to UPS trucks to the trucks that a home service fleet would drive when going around the neighborhood. So these vehicles are purchasing the gasoline from the retail gas station. The fleets themselves consumed over 60 billion gallons of that motor gasoline in 2022.

3:29So for reference, WEX is serving probably by our estimates, I don't know, around 25 to 30 % of the overall market. and they currently have 18 million vehicles on their platform. And 600 ,000 fleet businesses use the WEX card. And so it's a huge market in general. And you can think of the overall market from at least our analysis is still 30 to 40 % untapped. And that 30 to 40 % is just fleets that have not adopted a fleet card from one of the providers? Correct. Yeah. So there's a few different fleet card providers that go into that number. And about 20 % of that 40 million fleet vehicles is likely unaddressable because they don't actually buy their gas at the retail gas stations.

4:15Those are things like school buses and other government agencies that don't purchase gas from retail gas stations. But yeah, when you look at the overall market between WEX and a few of their competitors, there's still 30 % of fleet vehicles out there that don't use a fleet card. So that market remains untapped. Out of curiosity, where do school buses get their gasoline from? So they actually have their own private fleet fueling locations. So they're not going up to your local Exxon station to fill up. I've never seen a school bus at a local Exxon station. So that explains that. It's an interesting business niche.

4:52And I think about for corporates, there are corporate Amexes and a variety of different cards that we can use for traditional business. What's the history here in terms of this industry being created, WEX being created? How did it come to be? So WEX has been around for a while. They've been around for about 150 years now. And actually, back in the 1890s, the company started under the name of A .R. Wright. And A .R. Wright was the guy, Augustus R. Wright. And he started a company with the name A .R. Wright that sold coal and ice in Portland, Maine. And so the company operated for about 100 years.

5:29and then they expanded from coal into heating oil and gasoline and diesel. And then in the late 1980s, the grandson of A .R. Wright had this idea of, can we create a card system that helps fleet operators eliminate fraud and provide the ability to run analytics on their fuel consumption? But even back in the 1980s, which was, what, just 40 years ago, the business was still almost too visionary for its time. So at the time, less than 3 % of all gas stations in the US had any sort of electronic equipment needed to process MasterCard or Visa transactions. So what they did is they started with three unattended gas stations in Portland, and they signed up their first fleet customer, which was a dairy company called Oakhurst Dairy.

6:15And so fast forward a few years, ATMs and credit cards begin to proliferate. Simultaneously, Shell and Mobile begin to launch their own plans to launch their own fleet car businesses. And this began to give AR Wright some of the credibility in the space. And so they went down to Boston and they raised venture capital funding under the name Wright Express. And so that's where you can start to see the name WEX originating from was originally Wright Express. So the pitch was genius. Instead of winning over gas stations one by one, they would actually go to the corporate oil company. And then they would sign up the oil companies.

6:50And then the oil companies would tell their retail gas stations all to use Right Express as a way to win fleet businesses and win loyalty with these various fleet operators. And in 1987, Right Express signed their first big oil company. It was a company called Getty Petroleum. They got GE Capital actually to carry the credit. And they began white labeling their card and partnering with other oil companies and financial networks. And then finally, they were acquired a few times, went public in 2005. And since going public, they've 20X their revenue over the last 20 years. In 2012, they rebranded from RightExpress to WEX.

7:26They built out their own proprietary payments network. And today they do about $2 .5 billion in revenue and they have 600 ,000 fleet customers. Wow. So in that early instance of getting that oil customer signed up, was that very much dependent on that retail relationship between the oil company and having the actual gas stations where they knew there would be a flow through? in terms of fleets using and creating that loyalty at that specific gas station. Was there anything else that went into that convincing of the oil producer to be pushing on behalf of WEX? So the oil producers wanted to be able to develop a relationship with their customers so that their customer would continue to go back to their retail gas stations.

8:10What's unique about the oil and gas industry is certain retail gas stations are actually not necessarily owned by the corporate oil company. So for example, if you go out and you buy gas from an Exxon gas station, actually Exxon doesn't own a lot of its own retail gas stations. They just license out the Exxon name. And what's even more interesting about the retail gas space is when crude oil is refined into gasoline, gasoline from an Exxon refinery might be mixed with gasoline from a Shell refinery, which might be mixed with gasoline from a BP refinery. And all that gasoline in the same pipeline will go to a specific blending terminal where a specific brand will add their additives and sell it as Chevron with Tecron or sell it as Exxon with Synergy.

8:58And so the branding within gasoline actually just comes at the very end where they add their own additives and then they sell it under a specific brand name. But that's a relatively new concept. Back when WEX originated, a lot of these refiners and then retail gas distributors were still pretty vertically integrated. So at that point, you gained a lot of distribution leverage by going to the corporate because the corporate themselves still had the relationship with the end consumer because they still own the retail gas stations. Since it's become a bit more fragmented. But still, several of these corporates, BP, for instance, still own several of their retail gas stations.

9:40It's a really interesting industry dynamic. We recently did a business breakdown on Casey's General Stores and got into that breakup, essentially, where Hess sold a lot of those gas stations, obviously, Exxon as well. And some of the bigger producers have gotten out of that business. But it sounds like in the early days here, that was very key to the distribution. So it's interesting to know how it's evolved over the years, and they've been able to hold on to that stranglehold on the industry. That's how they've been successful. Otherwise, you have to go and you have to acquire each retail gas station individually.

10:09And the customer acquisition cost just doesn't make sense. But if you can figure out a way to gain that leverage by going through the corporate, then you can sign up a lot more gas stations. You can sign up, in this case, tens of thousands of gas stations with low customer acquisition costs. And in terms of the fleet owners, the value proposition there, I think you alluded to some of this before in terms of visibility, in terms of mileage at a certain point, just reducing fraud that might have been taking place, I assume at the truck driver level. But what is the value prop in providing these cards to the fleets?

10:43So number one is to be able to control spend and be able to actually have insight into what the fleet drivers are actually spending when they purchase gasoline. So when you use the WEX credit card, you get access to data like the amount of the purchase, the driver that made the purchase, the vehicle type that the driver was driving. And then through the WEX software, you can have various reports that WEX creates. So ultimately, it just gives you more visibility into your gasoline consumption, which is a massive span for some of these fleet providers. And then from the driver perspective, you can actually use the WEX card at various auto centers.

11:23So you can use WEX credit for changing your engine oil, for example. So depending on what card you use, you can get certain points and certain benefits associated with it. And how does the economic model work? Is it a traditional credit card type transaction as a consumer where I'll be charged an annual fee and then maybe fee if I'm not paying on time? Are there also just transaction fees associated with it? How do they generate money from the fleet card? So in their fleet segment, WEX has actually built out their own proprietary payment loop. So what that means is it's actually in fleet or in mobility as they've rebranded it.

12:01WEX doesn't have to use MasterCard or Visa in order to process those transactions. WEX can actually capitalize on a significantly greater portion of those interchange fees for every transaction. So it depends on how they've negotiated it. But for all intents and purposes, it's a percentage of every transaction. And then with the software products that they also sell in order to give visibility into the transactions, they charge SaaS fees for those. So it's both a percentage of spend and then SaaS fees on top. And is that percentage of spend, I think, of 3 % on the high end with the Visa and MasterCard?

12:35Is that the right context? Or is there a large meaningful difference from that number? No, that's the right context. Yeah, about that much. Super interesting. And when you think about the marketplace competition, what does that look like in terms of other fleet card providers? So WEX is one of the big three. The two others would be Fleet Corps, which serves about 800 ,000 businesses, has 24 million vehicles. For reference, WEX was 600 ,000 businesses and 18 million vehicles, so not too much bigger. And then the other one is Voyager Bank Card, which is the third biggest. And so we think between those three biggest, they probably serve about 50 % on the market.

13:12And is the competition strong? Is the switching cost high to go from if you're a fleet and you switch from one card provider to the next? Is there significant switching costs associated with that? How do you, from the outside, think about competition and whether it's pricing rates, whatever it might be, the threats towards one of those industry, one of the big three coming out, winner take all? There is a bit of stickiness because you've already implemented the software on your side and you have certain workflows set up throughout your organization in order to look into various spend and you've distributed cards to all of your fleet drivers.

13:49So there's a bit of stickiness. I will say that when you look at a few of the risks that WEX is currently undergoing, is competition is actually beginning to force them to reduce their fees and take a slight hit on margin. So we have seen WEX's historical profit margin over time begin to erode. So what they're doing in order to build up that moat is signing these longer term relationships with their fuel providers. And I think that also becomes something that makes the product sickier is that if you can offer the WEX card at various locations, and currently WEX serves nine out of the 10 biggest fuel providers in the US, then your drivers can use the WEX card wherever they're at along their route.

14:34And that ability to have those long -term relationships with the fuel providers themselves or with the retail gas stations creates a bit of that moat because it just enables convenience for the drivers to fill up wherever they are. But that being said, they are beginning to see reduced fees and reduced margins because some of their competitors are starting to undercut them and provide greater discounts or whatever it may be to the drivers themselves. And what does this business do just in terms of run rate, revenue, margin, however you look at it? How would you classify the fleet business with those metrics in mind?

15:11So overall, the business says $2 .5 billion in revenue, which is about 25 % year -on -year growth. The fleet business is about 60 % of that revenue. So they do have two other parts of their business, which are related to B2B payments, and then managing various travel and corporate solutions, and then health and employee benefit solutions. But the fleet business, which is their main product, does about $1 .5 billion of revenue at very high margin. So 72 % gross margin, 50 % operating margin. And if you look at the overall EBITDA of the business, it's a 35 % EBITDA business. And one of the things that sticks out is the transaction fee as a percentage of the sale.

15:54If fuel prices are higher, that's going to be a higher sale versus fuel prices coming down. How much of a role does that play just in terms of revenue generation? Well, WEX doesn't use any hedging derivatives. So they're fully exposed to the impact of fuel price volatility. So if your volume amount decreases, and if you're taking a percentage of volume, then it's an impact on your top line. And then if fuel prices are too low, then the dollar amount per transaction is too low. and that also affects your top line. So there is a sweet spot, actually, where WEX can optimize revenue. And currently, they're fully exposed to the price of fuel.

16:33In terms of the customers, one of the interesting things about the trucking industry is that most fleets, I think 90 % plus, have fewer than 10 trucks. Do they have much customer concentration when it comes to revenue? Is it very diversified? Is there anything unique going on there? No, very diversified. So 600 ,000 fleets. So both on the fleet side, and then also on the fuel provider side, they've actually been able to aggregate both the supply and demand. And it's really interesting is you can almost think of them as in a weird way, maybe even like a marketplace where they've aggregated all of the supply on the fuel retailer side, and then they've aggregated all of the demand on the fleet operator side.

17:19And then they can actually take a take rate, which is in this case, the interchange fees on all of the transactions between the two. Yeah. And capitalize on that volume. So they've done a really good job at starting with the supply side, starting with the fuel retailers, and then using the fuel retailers to develop those relationships with the fleet operators through various loyalty programs. When you were describing it before, it very much reminded me of a marketplace playbook in terms of going after those suppliers and even just thinking about the product on the marketplace being fuel, which you're typically looking for marketplaces to have something that's homogenous as the product or service that could be easily commoditized and taxis and Ubers are one form of this.

18:06But fuel is another form of it where it can be the special blends, but it is a commodity at the end of the day. So very interesting to think about how they've thought about this business very, very creatively. I would also say in a marketplace, you also typically want at least both sides to be more fragmented. Otherwise, you get disintermediation of the marketplace and you get people forming their relationships outside of your marketplace. But if you're constantly filling up at new fuel stations or you're constantly selling to new drivers, then managing the complexity on both sides is actually really beneficial.

18:37And is there anything else to consider? I think we talked about some of the risks from competitors as it relates to offering different things to the fleets. But as it relates to the suppliers and now being with nine of the top 10 fuel retailers, are there any threats from that side of the business in terms of them asking for specific terms or adjusting the model that are worth considering? One thing on the supply side, which is maybe different than your original question, which might have to do with forming these long -term contracts or long -term relationships. I think that we should highlight on the supply side is the integration of electric vehicle charging into some of these gas stations around the country.

19:21As more and more fleets become mixed fleets and as more gas stations start to look at electric as a significant portion of their revenue, WEX is currently trying to get ahead of the curve there in order to offer different solutions to EV drivers. So currently, WEX captures about $6 per vehicle per month on their gasoline fuel car product. They think that they could capture anywhere from, I believe it's $5 to $20 per vehicle per month, because you can actually monetize an electric vehicle in several different ways versus a combustion engine vehicle. And because that's different things like helping them find charging locations, helping them monitor their battery performance, reimbursing employees if they were to charge at home instead of at a fleet depot or their office location.

20:11So one of the risks to the business that's less on the contracting side and less on the relationship side, but more on the macro side or the macro dynamics is the integration of electric vehicles into some of these fleets. And can you elaborate on that a bit just in terms of if someone is refueling an electric vehicle at home, how they would go about transacting that and capturing some value? So imagine you're a fleet driver, and you have a company provided vehicle, but you charge your vehicle at your house overnight, for instance, the company wants to be able to figure out a way to reimburse their employee for charging at their home and spending money on essentially fuel costs, which are electricity costs in this case.

20:59So there needs to be a way, there needs to be an app or some sort of reimbursement system so that the employee can charge at home, but still get credited by their employee for the electrons, in this case, that they put into their vehicle. And so WEX is looking at various different methods and building various different products to be able to figure out, okay, how can we implement some of these new applications that might not be relevant in the combustion engine world, but are relevant when mixed fleets begin to integrate electric vehicles. That makes a lot of sense. And I think it gets into their broader expansion into other business lines as well, just in terms of doing what they do and then seeing what other options and services that they can offer on top of that.

21:47So maybe it makes sense to transition into some of the other businesses they have. I think travel and corporate solutions is a sizable chunk of the business. So maybe you can describe a little bit about what they're doing there. So travel and corporate solutions makes up about 20 % of the business, which is about 500 million in revenue, also a very high margin business of 70 % gross margin, 50 % operating margin. And what that business is, is two main products. So one is B2B payments. And this is a payment platform that's mainly used by online travel agencies and various tour operators and airlines.

22:23And then the other is AR and AP automation and spend management software. So within this division, they also make money from interchange fees when they offer B2B payments. This product is actually not on their flows loop proprietary system. This product is actually powered by MasterCard and Visa. So it's not as high of a margin on those interchange fees, but still significantly strong gross margin. And then on the AP automation and spend management software, they sell a SaaS product. And when you think about growth with that business, how does it relate to the growth of the fleet business? Is it something that management views as a core business line that they're really focused on?

23:06Is there any difference in terms of focus for the management team or shareholders when it comes to this versus the fleet solutions business? When you look at their 10K and you look at how they talk about the business and where they're investing, they just set aside actually a $100 million venture fund specifically for scouting new technologies within e -mobility. So you can start to get the idea that fleet solutions and mobility solutions more broadly is the core focus area of the company. And I would say that's consistent with how management talks about the company at their earning reports. Well, I think even though it sounds like it's not the focus, it does make sense to still tap into the remaining 20 % of revenue in this health and employee benefit line.

23:51So what is going on there? And is that another extension in terms of what they're doing with businesses? So in that health and employee benefit solution line, they provide software with payments attached and plan administration services for health benefit accounts. So think HSA accounts and COBRA accounts. And what's unique and actually something that we haven't touched on yet, is there a non -bank custodian of $4 .5 billion in HSA assets? And this division is powered by Wex Bank. So Wex Bank actually powers all three of their core business lines. And it's a wholly owned subsidiary, which funds these other business lines.

24:29So it funds the fleet products, and it funds the corporate solution products. And it provides the credit that's needed on those fleet credit card transactions. And it's the depository for the HSA cash assets. So one thing that allows Wex to access a lower cost of capital is the fact that they have Wex Bank. And Wex Bank provides that competitive advantage and liquidity that enables them to design various funding solutions and payment solutions for their customers. Always a secret low cost of capital float involved with these businesses. And another great example here, when you put all of the businesses together, what does the overall financial profile look like from a revenue and margin standpoint?

25:112 .5 billion in revenue growing 25 % year on year, 60 % overall gross margin, 35 % EBITDA margin, 15 % net profit margin, 900 million of cash in the balance sheet. Very, very strong business. Business has been growing very rapidly top line, 25 % scale. And at those margins, I think commands a pretty healthy multiple. And that 25 % growth, can you attribute that towards new logos and bringing them in or just capturing more business from existing customers. What was driving that? It's primarily just continuing to tap into new customers, continuing to really sign up these customers at scale, actually add new fuel providers to their network.

25:58I believe they just added Chevron as a major partner to their network. So it's continuing to chip away at that overall market of undigitized fleets, because it's still significant untapped market opportunity. And how do big players like an Amazon or a Walmart where they are the privatized businesses, do they show up as potential customers here as well? They do, yeah. So Amazon, for instance, with all of their delivery drivers, fill up their gas tank just like anyone else at these retail gas stations. Amazon surprisingly is one of the leaders in transitioning their fleet to EV fleets or electric vehicle fleets.

26:39So Amazon has tens of thousands of electric vehicles in their fleet. And so they're leading the EV charge on pushing other fleet vehicles or influencing the transition to mixed fleets. And they're one of the reasons why WEX wants to get ahead of this curve. So 25 % growth, top line, still a major penetration opportunity. From a margin standpoint, you alluded towards competition, putting some pressure in terms of fees. Where do you see that going? And where has that historically trended over time in terms of margins? Over time, their fleet solution has done about 50 % operating margin. Most of the margin is spent on hosting various software solutions and then providing that infrastructure for payments.