2023-08-05 02:23:40 ET
Summary
- I upgrade my rating on HLI from hold to buy given my increased confidence for CY24.
- HLI's 1Q24 financial results showed positive signs of improvement, with increased revenues from restructuring and optimism about future growth in Corporate Finance and Financial Advisory & Valuation.
- I believe that as M&A activity increases, it will support revenue from different business units, and the Financial Restructuring unit is likely to benefit from the current interest rate environment.
Summary
Houlihan Lokey ( HLI ) is a boutique investment bank in the United States that specializes in serving middle-market clients in the areas of corporate finance advisory, restructuring, and financial valuation. Readers may find my previous coverage via this link. My previous rating was a hold as I believed HLI I await clear proof that the M&A and hiring environments have improved. I am revising my rating from a hold to a buy as there is now better visibility into CY24 recovery, which should drive HLI earnings as revenue flow comes back online.
Financials / Valuation
For the 1Q24, HLI recorded $416 million in revenue, $84 million in EBIT, and $0.89 EPS. Corporate Finance revenues were down 14%, but management was optimistic about the future, citing a slight uptick in the M&A environment after six consecutive quarters of weak operating environment. Revenues from restructuring increased by 56%, and management expects that this area will continue to see strong growth and high levels of activity for the foreseeable future. And finally, Financial Advisory & Valuation [FVA] revenues fell 14% sequentially but are forecast to rise as the year progresses. This makes sense, as the independent valuation provided for M&A deals nearing completion drives a significant portion of the FVA segment. Management is optimistic that FVA will continue to rise from here because industry M&A activity is expected to pick up.
Based on the new outlook for HLI and recent results, I expect to see a strong rebound in FY25, with the rest of FY24 showing stable to positive growth. As revenue kicks in, I expect margins to improve, returning to their historical profile. At the current multiple of ~21x forward PE, it is clear that the market is expecting a strong recovery in the coming year. While I think the multiple could stay at this level, I took a more conservative approach by assuming HLI would trade back to its historical multiple. Based on my model, I have a price target of $125.
I previously had a price target of $137 based on $430 million net earnings (consensus estimates) and 16x forward PE. I modelled a slightly more conservative margin expansion for FY25, but the direction is the same. As the outlook is clearer now for FY24, I am switching my view to a buy.
Based on author's own math
Comments
Looking at the results, HLI reported an EPS figure that is below consensus estimate of $1.00. The decline in revenue and increase in comp expense caused the shortfall. However, it was heartening to see that management had faith in all three business units' ability to expand at the same time in the medium term. Management highlighted that better macro conditions and a recovery in the equity and debt capital markets are boosting client confidence in Corporate Finance, which in turn should spur increased M&A activity. Since we are probably in a peak interest rate environment and the US economy appears to be stabilizing (inflation is falling), I believe deal momentum is beginning to reaccelerate. I'd like to draw attention to the fact that, despite this positive sentiment, the number of deals fell by 32% sequentially and 24% vs last year. Hence, I anticipate that it will be another quarter or two before HLI sees a positive inflection in deals flow. As M&A activity increases, I expect it to support revenue from Corporate Finance and Financial and Valuation Advisory.
I also have high hopes for the Financial Restructuring business unit. Business restructuring is likely to benefit from the current interest rate environment. Earnings growth in the near future will likely be driven by restructuring, given interest rates being at their highest levels in two decades, and reduced system liquidity. This is reflected in the numbers, which show that HLI's restructuring revenue increased by 57% to $123.4 million during the quarter. Higher interest rates and the upcoming debt maturity wall, according to management, are expected to keep revenue high for the foreseeable future.
The final detail I would examine in greater depth is the cost line. This quarter, HLI's non-comp expenses increased to $75.6 million, or 18% of revenue, from the typical 14-15%. Although this increase was driven by softness in the top line, rent increases, and inflationary impacts on travel and entertainment costs are also likely contributors. As revenue streams are restored, I anticipate this percentage to decline over the next few quarters. One quarter's worth of data may not be indicative of the bigger picture because some of these costs are typically incurred in advance (for example, rent is a fixed cost and travel is an upfront cost to meet with clients).
Conclusion
I am upgrading my rating on HLI from hold to buy, as I gain confidence in the CY24 recovery. The company's financial results for 1Q24 showed positive signs of improvement, with increased revenues from restructuring and expectations of a rebound in Corporate Finance and Financial Advisory & Valuation. While the EPS figure fell below consensus estimates, management's optimism about future growth and improved macro conditions are encouraging. I believe that as M&A activity picks up, it will support revenue from various business units. Additionally, the Financial Restructuring unit is expected to benefit from the current interest rate environment. Although non-comp expenses increased, I expect them to decline as revenue streams are restored.
For further details see:
Houlihan Lokey Q1 Earnings: Upgrading To Buy As I Gain Confidence On CY24 Recovery