HCSG - Healthcare Services Group: Seems Pricey For What You Are Getting

2023-07-22 04:43:34 ET

Summary

• Healthcare Services Group Inc has cut its dividend to make way for buybacks and a more flexible financial position, but the author sees little value in the company at present.
• HCSG's move to cut dividends is part of a strategy to manage capital and rebalance capital allocations, with the aim of yielding larger returns to shareholders in the long run.
• Despite operating in a crucial niche within the healthcare sector, HCSG's workforce size and occupancy levels have not yet fully recovered to pre-pandemic levels, posing a significant challenge for the company.

Investment Outline

The healthcare sector seems to have been struggling quite heavily as the talks about reaching the debt ceiling would destabilize and limit some of the capabilities of paying out funds. But in recent weeks there seems to be a recovery as major companies like UnitedHealth Group Incorporated (UNH) and Johnson & Johnson (JNJ) both posted strong beats. This hasn't had such a massive impact on the share price for Healthcare Services Group Inc (HCSG) just yet, but time will tell as the next earnings report is coming up.

But what I don't see yet with HCSG is any significant value. The company is trading at a P/E of 20 and has historically paid out a dividend with a yield of around 5 - 6%, but has since cut the dividend to make way for buybacks instead and a more flexible financial position. I can imagine a lot of the appeal of owning shares previously was because of the dividend, but now I don't see enough to make it a buy. The measures will hopefully have an impact and I am rating HCSG a hold going into the earnings on July 26 .

Recent Developments

Not that recently, but worthwhile to include is the fact that the company back in February of this year said it's cutting the dividend. They cited the need to have a better financial position and more flexibility. But the news also included a new buyback plan worth $7.5 million which has been authorized for use. I don't particularly see the value in having such a small buyback plan, the market cap is after all over $1 billion. If HCSG wanted a stronger financial position then perhaps adding those $7.4 million to the cash position is better.

The move according to the management is in accordance with its attempt to manage capital and rebalance capital allocations strategy which in the long run aims to yield larger returns to shareholders. More capital will be freed up to invest in organic and inorganic opportunities to drive further growth. In 2022 the dividend paid out amounted to just over $63 million. Seeing as HCSG doesn't have any debt currently, this seems a little out of the blue honestly.

Perhaps the real need is to invest more aggressively into potential acquisitions to fuel growth. At least it would seem necessary when you view the latest earnings report from them, where they missed on revenues and saw a 2.2% YoY decline. Reversing this is a priority as otherwise, the 0.66 p/s multiple might look more expensive than it is.

Margins

The margin profile for HCSG is not a highlight of the company. The numbers are quite worrying as the TTM margins are all under the historical averages of the company. This isn't setting them up to be such a strong investment opportunity right now.

Historically, HCSG is sitting at some of the lowest margin points in its recent history. It has steadily been over 2% and climbed higher during the pandemic as many healthcare-related companies saw inflated revenues that eventually returned to more regular levels. But if HCSG continues to struggle to raise margins then I think the multiple needs to contract and reflect this risk. Somewhere around 12 - 14 would seem fitting. That would of course add a lot of downside potential right now to the share price.

Value For Investors

For investors, much of the value previously came from the divided, as it has been cut the question comes where investors are now able to get value. It's not from buybacks that's for sure. The company only permitted a measly $7.5 million in authorized funds for buying shares. That isn't enough to even buy back 1% of the outstanding shares.

It seems irresponsible to be buying back shares now when the valuation is where it's at. Buying shares at a 20x P/E doesn't exactly scream undervalued. It may be under the historical p/e of 25 for HCSG but that doesn't justify it as a good buy now in my opinion.

Risks

HCSG operates within a crucial niche, offering essential services to the healthcare sector in the U.S., encompassing management, administrative, and operating support for various departments in nursing homes, retirement complexes, rehabilitation centers, and hospitals. Historically, this industry has demonstrated resilience, proving to be less susceptible to economic downturns and other headwinds.

Despite ongoing efforts, the company's workforce size and occupancy levels have not yet fully recovered to their pre-pandemic levels, and this remains a significant challenge for the organization.

Looking at the last income statement here as well, the company has been diluting shares at a small rate to YoY, which of course brings downside risk for the share price and affects investors' position in the company.

Company vs Peers

There are plenty of companies in the healthcare industry that provide a decent dividend. For me, the obvious choice is honestly JNJ. They have a yield nearing 3% which is supported by a fantastic balance sheet. Besides that, a valuation of 20x earnings where HCSG is makes more sense for JNJ in my opinion. The quality you get when investing in that business is far superior when compared to HCSG. Besides, JNJ seems to offer more short-term upside as the p/e is 26% below the sector, and with a solid last report , the risks seem limited.

Investor Takeaway

In conclusion, when looking at HCSG, I think they offer some decent potential as they are taking what they view as necessary steps to reorganize and reallocate capital within the business. Operating as a service company in the healthcare sector, helping with housekeeping and facility maintenance, they seem to have a steady demand going forward. But the valuation makes little sense now without a dividend and the buyback plan isn't enough to entice me to make it a buy. As a result, I find HCSG to be a hold now.

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