HealthEquity: Convincing catalysts, fairly valued, buy recommendation again (HQY)

Investment update

Following my last publication on HealthEquity, Inc. (NASDAQ: HQY), the stock is up 14%, including a strong consolidation/distribution in July when the company announced that one of its business partners had experienced a cybersecurity incident. I have been optimistic about HQY since June last year (see the report Here), but we have been covering the name since 2021 (see previous publications Here) and notes a positive shift in fundamentals that is beginning to show up in the chart.

The stock is coming off a 5-year base where there was a prolonged accumulation phase of institutional + large accounts since FY2023 (the float is >98% owned by institutions, see: Figure 2) and the cybersecurity announcement + Q1 2025 earnings + the broad market sell-off in August have provided ample opportunity to buy this company at 17x NOPAT with the possibility of compounding to $93/share. This company is as defensive an overlay as any for equity risk budgets that are strategic Commitment but don’t see volatility in size. Bottom line, I’m again recommending a buy for HQY and targeting a ~10% CAGR on return on capital through FY26E at 17 x FY26 estimated NOPAT.

Figure 1.

Figure 2.

Convincing catalysts support repeat purchase

(1). Forward sales + profit ramp

HQY reported Q2 revenue of $118M (+18% YoY) on adjusted EBITDA growth of 36% (2x operating leverage) with a +540bps reduction in operating margin. Management has raised FY25 guidance and now expects revenue of ~$1.18B on adjusted EBITDA of ~$474M, leading to earnings of ~$3.10/share. Consensus is for $1.17B this year, which is expected to increase to ~$1.4B by FY26, which I think is a constructive sign, especially if there is an economic tightening – that’s the kind of recession-proof earnings I like.

Figure 3.

Figure 3.a.

(2). Fundamental dynamics from Q1 FY25

• Health savings account (“HSA”) assets also grew 22% year over year to $27 billion in the first quarter, underscored by 13% growth in HSA members, while deposit revenues increased 37% year over year to $121 million (HSA cash returned ~2.4% annualized through the end of the first quarter).
• But of the 22% or $2.1B growth in HSA assets, only ~1.5% or $0.4B was organic – the rest came from acquisitions, which is a point that needs to be critically analyzed. We don’t want HQY to scour the acquisition pipeline just for the sake of acquisitions – all acquisitions must deliver their economic contribution. After acquiring BenefitWallet’s HSAs, ~400,000 new HSAs and ~$1.6B in HSA assets were added (~6% of the current total).
• Encouragingly, the increase in operating profits is well executed (Figure 4) and the gains on capital employed in the business (discussed later) are well executed. There will always be some headwinds in a company with low-contribution legacy assets, but the fact is that investors will pay a good multiple for management that will redeploy excess funds into additional value-creating opportunities, whether they are acquisitions or not. Management was asked about this very topic during the conference call (specifically the BenefitWallet transaction) and about a potential “tailwind” from the current interest rate cycle, which led to the following response (per the Q1 2025 earnings call):

On the broader question of interest rate sensitivity of our performance, I think the answer is that the way to look at it is that the relevant question is what long-term portfolio advantage we will derive from a growing corpus of accounts and assets.

A reasonable answer in my opinion and I agree with that sentiment. Management also continually updates its repricing table and has completed a series of repricing in the ~100-150 basis point range through approximately fiscal year 2026.

Figure 4.

(3). Technical data bullish in the long term

• During sentiment swings and higher volatility, technicals provide unmatched opportunities to analyze trends and entry/exit points while remaining objective. The price structure has weakened since July, with a broader base and a 3-wave down move where we broke the cloud (see: the daily cloud chart in Figure 5), with both price and lagging lines. This is significant for the coming weeks, and in my view, HQY could corner sideways to gain ground before trading above the cloud again. This fits with a distribution-accumulation cycle, and the buying volume at $55 showed me that confident buyers are participating in this auction (i.e. LT institutions).

Figure 5.

• But on the weekly cloud (looking ahead to the coming months), this demand zone was critical because 1) it bounced right off the cloud base (now green for 3 weeks in a row) and 2) the trailing line never broke the cloud anyway. This could have been a bit of a washout as some of the weaker hands in this trend since 23 stepped back and brought the bid down to $55 as mentioned. That HQY never broke the cloud base in price or the trailing line tells me I should remain bullish on this name long-term – i.e., look for meaningful upside in the coming months and years.

Figure 6.

Fairly assessed, without high hurdles to overcome

There is no 7-foot hurdle that HQY needs to clear to trade above the current range, and my numbers (see: Appendix 1) put me at ~$92/share by FY 2026. Under current conditions (that is, if HQY continues to dance to a similar tune), this is ~17x NOPAT or ~2.5x EV/IC. This makes the case for a buy in my opinion.

Valuation Insights

• Every dollar management invests in HQY’s operations is worth more than $1 to the market. From fiscal years 2021 to 2024, ~$216 million was reinvested in the company to increase competitiveness and growth. The market has valued this at 7.3x, creating a market value of ~$1.5 billion from this additional capital. Therefore, management can afford every additional dollar it can – or, more importantly, has the opportunity to, if it gets very high marks in my opinion – invest in operations. My estimates are that it reinvests ~14-15% of NOPAT every 12 months.

Figure 7.

• HQY currently trades at ~17-18x NOPAT and that’s fair in my view as 1) ROICs are up +200bps from FY’21 to ~13% even with all major implementations during that time, 2) incremental gains are increasing with every dollar of new investment in the business – which as mentioned is very valuable, and 3) it still generates >$300M in free cash after accounting for all reinvestment requirements to maintain competitiveness and growth every 12 months. Operating at the ~17x multiple supports ~$92/share through FY’26E or ~9.5% CAGR. If it rises to ~19x (with higher ROICs) we get to ~$100/share and at 16x = ~$83. The safety margin is ~12% and could allow a contraction to ~15.5x according to my assumptions. The distribution of results with different multiples + growth rates can be seen in Figure 9.

Figure 8.

Figure 9.

• Finally, the discounted value of free cash for a private owner of the company above a comparable level of risk (in this case 6%, then discounted at 12%) under these assumptions is approximately $98/share. This is similar to the ranges mentioned previously and adds more confidence to the estimates. This makes the case for a buy.

Figure 10.

Risks

The main downside risks to the thesis are 1) Sales

These must be fully known before proceeding.

In summary

HQY remains a buy in my opinion as 1) there are several compelling catalysts in place that influence price change, 2) valuations are acceptable at ~9-10% CAGR through FY2026 under baseline scenarios, and 3) there is an option to buy a high-quality franchise

Appendix 1.