RGP - Resources Connection: Undervalued But No Clear Buying Signal As Of Yet

2023-12-07 22:30:16 ET

Summary

• Resources Connection stock may be showing signs of a bottoming process, with a positive divergence on the MACD indicator.
• Buying volume needs to accompany the price increase for confirmation of a bottoming process.
• RGP stock is undervalued based on its self-funded nature and dividend analysis, suggesting a potential upgrade from 'sell' to 'hold'.

Intro

We wrote about Resources Connection , Inc. ( RGP ) back in June of this year when we deemed the stock a 'sell' due to its unforgiving technicals. Negative growth & deteriorating EPS revisions were prime reasons for the bearish technicals at the time as shares continued to make lower lows. Shares are down just over 9% over the past 5+ months which is a considerable opportunity cost considering the S&P 500 is up close to 5% over the same timeframe.

If we return to RGP's technicals by pulling up the stock's intermediate 7-year chart, we see that we may be getting an early sign of a bottom in this stock. The MACD indicator first of all is especially noteworthy on long-term charts due to the analysis of RGP's trend & momentum over time. A positive or bullish divergence takes place when the MACD is well below the zero line (what we have) and starts to move in a different direction from the share price (what we also have). Furthermore, heavy support between the $13 and $14 levels also aided shares of RGP in at least delaying this recent downturn. The one disclaimer we would put out there is that divergences that go against the prevailing trend (bearish) cannot be counted on. More evidence is needed.

12-Month Daily Chart

If we turn to RGP's short-term chart, we see that although shares are up roughly $1 a share (7%+) from their October lows, buying volume has not accompanied the move. Therefore, if indeed, RGP is undergoing a bottoming process, we would need to see the OBV line (On Balance Volume) to break above the bearish trend-line depicted below. Suffice it to say, the MACD divergence alluded to on the technical chart is immaterial really until we see volume trends change for the better in RGP.

Forward EPS earnings revisions aside (which remain ugly), the lower this stock goes, the more it will interest value investors over time. As we see below, RGP's assets, sales, earnings & cash flow are all trading below their respective 5-year averages. Furthermore, RGP's dividend yield of almost 4% comes in higher than the company's respective 5-year average of 3.56%.

Valuation & Dividend Analysis Point To Undervaluation

So here's the deal. RGP will eventually bottom because it is self-funded (internally generated earnings & cash flow). We acknowledge that its growth curve (-20% GAAP Earnings growth over the past 12 months) has been pretty abysmal in past times but shareholder equity has still been growing even in a pretty severe downcycle. The company's testament to this is the fact that $81 million of free cash flow was generated over the past 12 months in an environment that has seen RGP's market cap fall by over 25%. Suffice it to say, since RGP's dividend remains well-covered from both an earnings & cash-flow basis, we can use the following dividend discount model to ascertain whether Resources Connection stock is undervalued at present.

EDPS means expected dividend per share, CCE is denoted as cost of equity & DGR is the dividend growth rate. We calculate the dividend growth rate by multiplying RGP's GAAP retention ratio by the company's return on equity. Since the company's GAAP trailing pay-out ratio comes in at 48.28%, the company's retention ratio automatically is 51.72%. Multiplying this number by Resources' trailing ROE (9.7%), we get a dividend growth rate of 5.02%.

Therefore since Resources' current dividend per year comes in at $0.56 per share, our EDPS or expected dividend per share now comes in at $0.59 per share. This leaves us with CCE (cost of equity) which is a crucial metric as it relates to the minimum return investors are prepared to earn for investing in Resources Connection. We calculate this (using the below formula) where we use the 10-year US Treasury bond as our risk-free rate and a third-party calculation as our 'equity risk premium'

Cost of equity = Risk-Free Rate + (Beta) x (Equity Risk Premium)

Plugging the required numbers into the formula we calculate RGP's cost of equity to be 7.72%. Therefore...

Value or 'Worth' of Resources Connection = $0.59 / (0.0772 - 0.0502) = $21.85 per share (Well above the present share price of approximately $14 a share)

CloudGo Pte Acquisition

Although the recent purchase of CloudGo Pte Ltd may have gone under the radar (due to the financial details of the transaction not being disclosed), the Singapore-based consulting should fit directly into RGP's Veracity business where growth is expected to continue in the global digital consulting in the Asian-Pacific region. Being in business for close to seven years now, CloudGo Pte has demonstrated it can add significant value to its customers; hence its rapid growth curve in recent years. This deal should encourage RGP shareholders as it demonstrates that there are pockets & jurisdictions of the consulting industry that are still on the rise. Plenty of synergies should come from teaming up with Veracity where the use of machine learning and A1 through the ServiceNow cloud platform should only grow from here going forward.

Conclusion

To sum up, given Resources Connection's sustained profitability and the fact that shares look to be trading under their intrinsic value by quite some distance, we are going to upgrade our present 'sell' rating on the stock to a 'hold'. The bullish divergence on the intermediate chart may be finally pointing to a hard bottom over the near term. We await further developments. We look forward to continued coverage.

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