HCSG - Healthcare Services Group: Sluggish Growth Margin Pressure Point To Lower Share Price This Year

2023-10-10 06:15:57 ET

Summary

• Healthcare Services Group shares have lost close to 29% of their value over the past 13 months.
• Q2-2023 trends show continued margin pressure and a lack of top-line growth for HCSG.
• HCSG's high accounts receivables pose a risk to the balance sheet and cash flow.

Intro

We wrote about Healthcare Services Group, Inc. ( HCSG ) in August of last year when we stated that the company needed to regain underside support to avoid printing a sustained pattern of lower lows. We issued a sell rating on the stock at the time due to the sustained trend of margin erosion and poor profitability, in general, leading up to the point. Although shares did consolidate (by not making fresh lows) from October of last year to March of this year (buoyed by earnings beats in Q4-2022 and Q1 of this year), investors did not take well to the company's most recent Q2 earnings miss (announced in late July this year) with shares having returned to their previous pattern of lower highs & lower lows. This means shares have lost close to 29% of their value over the past 13 months or so.

As we see from the company's intermediate 5-year chart, the steep decline in shares that followed the company's Q2 report this year has led to an intermediate death cross (crossing over of HCSG's 10-week moving average below the corresponding 40-week average) once more. Although we have a possible intermediate divergence in the MACD indicator playing itself out currently (which may be pointing to a near-term bottom), the recent bearish death cross trumps all in our opinion for the following reasons.

Q2-2023 Trends Point To Continued Margin Pressure (High Costs)

In the second quarter, GAAP earnings of $0.12 per share missed consensus by $0.05 per share. Sales for the quarter came in down roughly $6 million compared to the same period of 12 months prior. In our commentary last year, we pointed out how the lack of top-line growth was putting pressure on HCSG's profitability and this turned out to be the case once in Q2 this year. With rolling sales dropping by roughly 1.4% in the quarter, HCSG witnessed a 41% increase in SG&A costs which resulted in operating profit dropping to $9.8 million.

Suffice it to say, HCSG needs growth but there are no signs yet that this growth will come to fruition. In fact, as we see below, EPS revisions remain negative over the past 3 months which clearly demonstrates (like the stock price) that consensus continues with a bearish bias.

High Accounts Receivables Pose Risk To the Balance Sheet

The company's accounts receivables line item on the balance sheet continued its upward ascent in Q2 surpassing $380 million in the process. To put this number in perspective, receivables now make up almost half of the company's market cap so this trend has now become a critical issue for the company. Management did state on the recent Q2 earnings call that although May & June collection targets were not met, they did provide solace for a batter back end of the year trend. We shall see.

Nevertheless, the growing trend in receivables is directly correlated with the increase in short-term debt at the company ($40 million at the end of Q2). Suffice it to say, with the company's trailing operating margin only coming in at a mere 2.7% , collections need to be FAR better to ensure HCSG can turn over (provide) its products and services at a much faster clip over time.

Value

With respect to valuation, currently, Healthcare Services Group trades with a forward GAAP multiple of 16.14 which is well below its 5-year average GAAP multiple of 25.98. Furthermore, HCSG's forward book multiple of 1.57 comes in well below the company's 5-year average book multiple of 3.75. Although these multiples may entice some value investors (as the company remains profitable), investors should note two trends regarding HCSG's assets and earnings.

On the assets side, rising receivables (if not reversed) will lead to cash-flow headwinds and possibly more short-term debt being issued on the balance sheet. The key question regarding receivables is how much of it will be collected. Furthermore, the longer these collections take, the worse for HCSG not just from a cash-flow standpoint but also from an inflation one (collecting less purchasing power over time).

On the earnings side, margins as alluded to above have deteriorated plus the scale of buybacks has not impressed since the suspension of the dividend earlier this year. Suffice it to say, that existing shareholders are not being compensated as much currently as they were in past times which also is bearish.

Conclusion

Therefore to sum up, considering the stock's bearish technicals, negative EPS revisions , depressed margins, and high receivables, we believe HCSG shares will go lower here over the next few months. We look forward to continued coverage.

For further details see: