BBSI - Barrett Business Services: Business Resilience Cheap Valuation And Solid Buybacks

2023-08-04 16:36:41 ET

Summary

• Barrett Business Services, Inc. provides business management solutions to small and mid-sized companies in the USA.
• The company's staffing business declined and net profit decreased YoY, but they have implemented a stock repurchase program to support EPS.
• BBSI is experiencing growth in gross billings and worksite employees, and management expects consistent growth in Q3 and Q4.
• The stock looks cheap, and the earnings estimates seem to be too pessimistic given the still-strong labor market.
• The estimated upside for the next 12 month is >17%, so the BBSI stock is a "Buy".

The Company

Barrett Business Services, Inc. ( BBSI ) is a $620-million market cap firm that provides business management solutions, including professional employer services and staffing/recruiting services, to small and mid-sized companies in the USA. They handle payroll, taxes, workers' compensation, and other administrative tasks for clients' workforces.

BBSI has created a management platform that combines knowledge-based strategies from management consulting with human resource outsourcing tools. They use this platform to optimize human capital and help their business owner clients run their businesses more effectively.

Although the management claimed on the latest earnings call that Q2 FY2023 was a "strong quarter" for BBSI, I can't agree with that. Their staffing business declined compared to the prior year, attributed to repricing the portfolio and changes in recruitment strategies. Despite a YoY growth of 0.93% in total sales during Q2, the rising costs have negatively impacted the margins, resulting in a YoY decline in net profit of -5.9%. Source

The company faces macroeconomic risk factors, such as supply and demand variations by geography and cautious business owner sentiment. The slowdown in client hiring in Northern California and the Northwest, particularly in industries related to new residential construction, poses challenges to the company's growth in those regions.

On the other hand, analysts expected much worse EPS results than the company showed in Q2 - this fact may have allowed investors to distract themselves from the weak dynamics of sales growth:

What allowed the BBSI to so confidently manage the EPS figures? The answer lies in the firm's buybacks.

Although BBSI is currently facing challenges, it has started a new $75 million stock repurchase program in Q2. This program aims to continue reducing the share count, as has been the case for the past few quarters [since 2020].

Spending $75 million on buybacks at the current share price would decrease the number of outstanding shares by ~811 thousand shares, or roughly 11.8% of the total. Although it's unlikely that this amount will be spent within one year (I assume the program will run until the end of 2024 or early 2025), it still provides significant support for BBSI's EPS.

During Q2, BBSI experienced a 5% YoY increase in gross billings, reaching $1.9 billion. PEO gross billings also increased by 5.1% YoY, reaching the same amount. Additionally, worksite employees grew by 2% within the quarter, with the average billing per WSE increasing by 3%. From these dynamics, it seems that the company is utilizing its asset-light model to venture into new markets. And it has virtually no debt in case you wonder:

Based on the statements made by BBSI's management, it appears that the company is currently in a stronger position than before the pandemic. They confidently report that their efforts to secure new clients and worksite employees have been successful, leading to a consistent increase in the WSE.

It's impressive how resilient the company is. It seems like BBSI has the potential to gain even more market share once the macro situation improves. But how attractive does its valuation look now?

The Valuation & Expectations

The management expects consistent trends in controllable growth for Q3 and Q4. Client hiring has been slower, but Q3 is typically their most profitable quarter, the CFO notes during the earnings call.

The diluted EPS of BBSI increased by 30.8% YoY in FY2022. Due to the high base of comparison, analysts expect the EPS growth to be almost negligible by the end of FY2023. However, in the first and second quarters, there has already been mid-to-high-teens growth on a TTM-by-quarter basis:

According to Reuters , the unemployment benefits in the US have increased slightly this week, but layoffs are at their lowest point in 11 months. Despite interest rate hikes, the labor market remains strong and is expected to see employment gains in July.

Based on the macro setup, it appears that BBSI is poised to have a busy quarter that may exceed current expectations. From my perspective, there is potential for another EPS beat in Q3.

When it comes to valuation multiples, BBSI appears to be trading at a 30-70% discount to the enti re Industrials sector:

Looking at the history of BBSI stock, we can see that it is currently trading at a discount of approximately 17% when we compare the next-year EV/EBITDA multiple to the 15-year average:

Here you need to understand that buybacks usually lead to multiple expansions as the number of shares outstanding decreases and the market "thanks" the company for the "artificial support". Therefore, over the next few years, I would not only expect a return of the current multiple to its historical average but also an increase of this very average value by about 10-15%. But even with a typical return to 9x of EBITDA, BBSI's business should be valued 17.45% higher today at the next-year EBITDA of $68.37 million after adjusting the enterprise value for net debt.

The Bottom Line

I don't want you to think that BBSI is an unfairly undervalued stock that has no risks and that is simply unnoticed. There is some truth to that statement - with a market cap of less than $1 billion, the company may indeed be hidden from the general public and most hedge funds, leading to some distortions in its valuation. But perhaps the risks threatening HR-related services companies are indeed too great to be optimistic about the industry and BBSI in particular. The labor market is strong right now, but usually, after such strength as now comes a slowdown, and it is this slowdown that Wall Street seems to avoid pricing in, expecting mid-double-digit EPS growth from BBSI in FY2024. So one needs to be aware of that risk before you buy this stock.

Although there is a risk involved, I find BBSI to be an intriguing company. Their financial stability, along with their low valuation levels and active business expansion, I think make for a great buying opportunity amid generous buybacks.

The next-twelve-months upside I derived [+17.45%] is higher than I usually require for issuing a "Buy" rating, so I recommend readers to take a closer look at the stock even as it approaches its ATH levels:

Thanks for reading!

For further details see: