NRC - National Research: Reiterate Buy After Q4 FY22 Numbers

Summary

• National Research Corporation came in with a strong set of Q4 and full-year numbers.
• Profitability characteristics to continue generating long-term value at incrementally higher rates of investment return.
• Retaining buy, $64 long-term target.

Investment summary

Since our last publication on National Research Corporation (NRC) we've been pleased to see its stock catch a strong bid in-line with our buy thesis. We noted last time, "the market continues to reward bottom-line fundamentals over top-line growth", and NRC is clear evidence of that leading into the new year. The company posted its Q4 FY22' earnings this week and we remain constructive on its long-term outlook. We reiterate NRC as a buy, the conclusion based on 1) factors of profitability; 2) low capital intensity; and 3) high percentages of distributable cash to equity holders.

As such, we retain the long-term target of $64, reiterating NRC a buy.

Q4 results in detail

As a reminder, our previous coverage titled " [NRC]: market is discounting these factors " and included a deep dive of the firm's profitability, notably, that ROIC outpaced the hurdle rate by 4.8x turns at the time. Switching to the Q4 results , notable observations include:

1. As expected, the scheduled closing of its Canadian operations resulted in a pullback in YoY quarterly revenues to $38.14mm. This is a continuation from the previous quarter, and is likely already backed into NRC's stock price by estimation. Stripping back to the core business, top-line sales were up 7% YoY, otherwise a 200bps YoY gain in full-year turnover. Growth was underscored by price increases of ~2-3%, and cross-sales within the firm's existing customer network.
2. Moving down the P&L, operating income slipped back 500bps YoY to $12.24mm after a marginal uptick in OpEx, primarily due to a loss of leverage at the G&A line. It also clipped a $2.6mm FX headwind for the quarter. These results demonstrate a good degree of resiliency as inflationary inputs have driven up running costs and company overheads. Hence, we see this as a strength in the company's operating model.
3. Important to note, is that NRC ended FY22' with ~$147mm in total recurring contract value ("TRCV"), an essential revenue predictor for all contracts under renewal. This is flat with the previous quarter. Having this knowledge is beneficial to forward-looking estimates in the company's valuation. Notably, the TRCV continued to be compressed by NRC's continued push into growing its digital offerings, at the same time divesting from its non-core digital solutions.
4. We noted momentum has garnered in its Human Understanding Program ("HUP") with Novant Health. Readers might remember the last publication noted that "Novant is an integrated network of health systems spanning 4 states and is the owner of 15 medical centres and 600 clinics in these jurisdictions". In Q4, NRC added 4 additional organizations as clients under this division, where 2 were new conversions. Cumulatively, at the end of the year it had bolted on 11 organizations with ~1/3rd of this number being new conversions, the rest conversions from existing clients.

Fig. (1)

As a reminder, a company generates value for its shareholders with a high return on invested capital ("ROIC") that exceeds cost of capital. This goes beyond the accounting reality and looks at economic profit ("EP") instead. If a firm generates an EP, where the ROIC exceeds the hurdle rate, growth is accretive to value. If it doesn't, then growth is actually destructive to value. In the last NRC publication, we noted: "the pullback in the NRC share price has resulted in an asymmetrical value proposition...in buying NRC, we are receiving FY22 levels of TTM ROIC at FY18' market capitalization. With the latest curl up of ROIC trends this could serve as a solid bedrock for a NRC's market cap to re-rate to the upside". The market appeared to agree with this sentiment, allowing NRC to reprice back to longer-term range.

The undercurrents of the thesis are more abundantly clear when we look at the incremental performance of NRC over the 5-years. Here, I'll use NRC's annual data, starting with FY18' up to the end of FY22':

• NRC generated $176mm in cumulative NOPAT, with an additional growth of $5.8mm in post-tax earnings. It's achieved similar growth in earnings over the same time. For those observing Exhibit 1, you'll note periodic ROIC has been high and well above any hurdle rate. Immediately, we recognize the value in this display. The question then turns to how this pulled through to equity holders.
• It diverted an additional ~$33.7mm in capital investment to generate these growth numbers, a 17.3% return on incremental invested capital ("ROIIC"). Looking at the earnings side, the earnings ROIIC was 22.26%. Subsequently, it reinvested 19% of NOPAT/earnings to achieve the future growth rates, amounting to ~3-5% in both instances. This matches the stock's 4.2% CAGR from FY18-date.
• Net-net, 81% of NRC's post-tax earnings were distributable as free cash flows to equity holders from FY18-date - incredible value on offer in our estimation. Whilst its stock hasn't ran up the page, the trade-off has been the low variance of returns and minimal drawdowns.

Because it also generated a high EP, the growth stated above has been accretive to value. The periodic and incremental ROICs have beaten the hurdle rate at each step of the way. The consistently high EP represents an economic moat [as Buffett eloquently termed it]. The low capital intensity also means NRC requires a small reinvestment from post-tax earnings to grow.

Fig. (2)

Valuation and conclusion

Given the growth and reinvestment rates listed above, we assume the company can hold a similar profile into the coming 5-years. Hence, we value NRC at 32.5x forward earnings, at a FY23E' earnings of $38.5mm. We obtained the cost of equity combining the earnings yield and growth rate, per Roberts (1991) . The key supportive points for this multiple include the high periodic ROIC, and ~$11.85mm forward dividend to shareholders. Here we see NRC's market cap fairly valued at $1.25Bn, above current levels of $1.15Bn.

Fig. (3)

Net-net, this analysis demonstrate that NRC remains a buy in our estimation. NRC still warrants inclusion into equity portfolios for those looking to "shift up in the quality spectrum and position against long-term cash compounders" as we mentioned in the last report. Capital efficiency is a standout, and the ability to reinvest earnings at high rates of return are attractive features in the investment debate. We continue to see value in the stock and retain our long-term target of $64.

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