Previously we looked at the business valuation of Mastech Holdings (MHH). To summarize, MHH is an IT staffing company in a competitive yet profitable industry. The macro environment has punished all staffing companies to the floor as companies continue to lay off people. MHH is a spinoff, a contrarian pick and a cheap stock all in one.
View the first stock analysis post on MHH. This post is all about analyzing numbers and valuation.
Spider Graph and Business Valuation Overview
Some opinions on the graph above
- Low risk: With a strong and healthy balance sheet, the risk of MHH going bankrupt and investors losing their money is very small. Current national unemployment rate is at 9.4% and I believe the jobless rate will decline more than it will increase in the future. Note that I did not say in a couple of months or this year. I’m talking over 1 year to be safe.
- High growth: Growth is dependent on the economy. Growth of job rates is the max it will be able to grow.
- Undervalued: Big margin of safety from different valuations. Continue reading.
- Well managed: In operation since 1986. Plenty of experience with the founders still running the company.
- Good financial health: Very healthy. Strong balance sheet.
- Strong moat: Shallow moat. Lots of competition. Anyone can enter the industry.
Financial Statement Analysis
Balance Sheet Analysis
- Mastech has a healthy balance sheet
- $1.55 in cash per share. i.e. 53% of share price is cash.
- No intangibles (WOW! I like)
- No long term debt
- Current debt not a problem. Current ratio of 2.51
- Net net value is $1.80 which means the company has lots of tangible assets making up the stock price
- No drastic changes in cash, accounts receivables or other balance sheet items from the past 5 quarters to set off any alarms.
Income Statement Analysis
- Gross profit margins in the 19% range. Good for a staffing company.
- Cost of Goods Sold (COGS) is very high at 80+% but other competitors around the same size is also in this range. Obviously has to spend to attract employees and earn business. Visa processing and legal fees obviously costs a substantial amount per employee.
- Small net profit margin of less than 4% average and 2.4% in the latest quarter makes it tough in bad economies.
- No new issuance of shares
Statement of Cash Flows Analysis
- Cash flow statement is clean
- Has a bad debt of $258k from not being able to collect receivables. Some of its financial clients went bankrupt.
- Generates positive cash from its operations. No need for debt. (Excellent)
- Organically creates FCF. No need to use EBITDA to try and inflate their numbers (Excellent)
Overall the financial statements are very clean, the business looks to be running smoothly without risk of going bankrupt in this tough environment.
Fair Value Calculations
Discounted Cash Flow (DCF) Fair Value
First using the discounted cash flow method. We see that MHH has been able to generate FCF for the first time as a standalone company in one of the worst years ever. Their history also shows how they have been able to generate cash while being a wholly owned subsidiary of iGate. With this, I’m confident that they will be able to generate more FCF in the future as well.
So to make some assumptions, I’ll use my FCF value of $3.8 million, assume 0% growth rate for the next 10 years and then a terminal rate of 3%. These are very conservative figures. Apply a 15% discount rate, I could use 20% as well but I don’t need to fiddle with the numbers.
- The DCF method gives me a fair intrinsic value of $9.40.
- 50% margin of safety means the buy price is $4.70
- 69% discount to current price of $2.90
Benjamin Graham’s Formula Valuation
This formula uses normalized earnings and with a 0% earnings growth rate, Ben Graham tells me that MHH is worth $3.77. If I were to apply a growth rate of 3.5%, which is basically the 10 year treasury rate;
- the fair value would be $6.21
- 53% discount to current price of $2.90
Net Net Working Capital Valuation
As I mentioned above, the net net value is $1.80.
When I calculate the net net value, I ignore property and all other assets except 100% cash, 75% of accounts receivables and 50% of inventories.
Multiples Valuation and Competitor Comparison
Competitors I am comparing that were mentioned in the annual reports:
- Analysts International Corporation (ANLY)
- Computer Task Group (CTGX)
- TSR Inc (TSRI)
Other value and Magic Formula staffing companies:
- Barrett Business Services (BBSI)
- Manpower (MAN)
Looking at all these companies side by side, I can’t help but see how much better MHH is.
- MHH PE is is at 3.6 while the average is 18
- Price to cash flow is a low 3.26 compared to average of 12
- Price to FCF is 1.86 compared to average of 5
- EV/Revenue (TTM) is 0.06 compared to average of 0.13
- Less of a decline in growth compared to all its competitors except CTGX
- Financially stronger than most
- Profitability is in line with competitors but profit margins are the best
- Excellent ROA, ROE, ROIC. Much better than competition
On ALL counts MHH performs and executes better than its competitors yet it is trading at a PE of 3.6 and this is even after it ran up 50% or so following its 1st quarter results.
If I was to assume a multiple of 10, which is still conservative, the fair value comes out to $8. Note that I am using their latest EPS with this multiple. I didn’t even bother factoring in how their earnings will definitely increase.
Also, the spinoff price was at $9 which is in line with everything I’ve written here.
See all the numbers for yourself in the spreadsheet below.
MHH Competitor Comparison Spreadsheet
I hold MHH at the time of writing.