TH - Target Hospitality: Potential Short-Term Positive Catalysts

2023-09-22 12:28:31 ET

Summary

• Target Hospitality is a modular housing community company serving the energy industry and US government, with a majority of revenue and profitability coming from government contracts.
• The company operates 27 communities with almost 17,000 available beds, providing modular housing and services to large energy companies in the Permian basin.
• The company is seeking a five-year contract for housing unaccompanied migrant children in Pecos, Texas, which could significantly impact the company's valuation.

The Basic Business

Target Hospitality ( TH ) is a modular housing community company serving the energy industry and US government, primarily through migrant influx housing. With the open borders policy of the current administration, the government business has grown materially over the past 2-3 years to a majority of revenue and profitability, and appears poised to grow further.

The company currently operates 27 communities with almost 17,000 available beds. The energy component is centered around the Permian basin and is contracted with large energy companies where they provide modular housing and services such as catering and even healthcare. These companies have large installed bases in the Permian and have a multi-year history with the company at a 90%+ renewal rate. Looking back historically, this is a solid $100 million EBITDA business.

The government component is 11 sites centered around Pecos, Texas that are built to house 3,000 unaccompanied migrant children. They have housing, education, recreation, dining, and medical facilities. The Pecos contracts have been granted in six month to one-year time frames. The company is currently seeking a five-year contract for Pecos. I believe the company should be hearing whether or not they get a five-year deal in the next month or so. If they do, I believe it fundamentally changes the valuation from one where revenue and cash flow are immense but perhaps ephemeral, to one that people can apply a real discount rate to.

That $603 million of revenue translated to $368 million of discretionary cash flow over the LTM ended 6/30, which is consistent with the trend of the past few years.

Importantly, these revenue and cash flow figures are just for contracted minimum payments to have the facilities ready to take in children. The facilities have had low occupancy so far this year, which is surprising given the migrant influx. The company earns incremental revenue at high margins for providing services when kids are at the facilities. This "variable services revenue" can provide upside as occupancy increases, which it has over the past few weeks.

New Facilities

In addition to waiting on a multi-year extension for Pecos, which I believe would approximate close to $200 million of high margin revenue, the company has only submitted bids for three other ICF's (Influx Care Facilities) of similar size to Pecos that the government has solicited RFP's to house migrant children. One contract was awarded last week to another company. The company believes they are well-positioned to win one of the two other contracts, but that is out of their hands. If they win one, I think it makes the stock perform quite nicely on its own. If they win a contract and get Pecos extended for several years, I think it can supercharge the stock.

Valuation

As mentioned above, the stock is not discounting any continuation of the past 12 months of operating results, which again, weren't even maximized given the low occupancy and lack of variable services revenue. Laying out the numbers shows this clearly.

Risk

The main risks are:

• The government canceling the Pecos contract this year. I see virtually no chance of that happening. The stock would trade to single digits if it happened, though.
• The government extending the Pecos contract for just one year. I see perhaps a 30% chance of that happening. The stock would likely trade down $2 if that happened, but it would generate $2 in cash over the coming 12 months.
• The government not handing any of the new contracts to TH. This possibility is hard to handicap. However, interestingly, if the company gets a 5-year Pecos extension, it won't matter (at least not to me) whether they get one of the new contracts. Conversely, if they get one of the new contracts, Pecos will matter much less.
• Some sort of scandal occurring at Pecos. It's a facility for unaccompanied minors. Lots of opportunities for things to go wrong there.
• Oil and gas prices crash and the companies facilities business contracts get renegotiated. I think this would only be temporary and oil is in great shape right now.

Conclusion

I think this company has a great risk/reward profile. If they get a 5-year extension at Pecos or they win one of the new contracts, I think the stock can move up 50% at least. If they get both, the stock could more than double. I think there are small chances of downside events occurring, all of them are acceptable in terms of price action, and none of them would put the company in any kind of distress.

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