2023-11-02 10:45:40 ET
Summary
- Houlihan Lokey's 2Q24 results reinforce the recommendation to buy, with strong revenue performance in the Corporate Finance segment indicating a favorable recovery trajectory.
- The potential for multiples to stay at 19x forward P/E could yield further upside for the company.
- The restructuring segment has not yet demonstrated a recovery, but management expects it to maintain robustness due to rising interest rates and impending debt maturities.
Summary
Readers may find my previous coverage via this link . My previous rating was a buy for Houlihan Lokey ( HLI ) as there was better visibility into CY24 recovery, which should drive HLI earnings as revenue flow comes back online. I am reiterating my buy rating as HLI 2Q24 results give me further confidence regarding my assumptions made previously. The recovery progress appears to be on the right track.
Financials / Valuation
2Q24 Operating income was reported at $84 million on revenue of $416 million after accounting for compensation costs of $256 million. Adjusted 2Q24 EPS of $1.11 was reported, which was 8% higher than the consensus estimate. Despite the Restructuring segment's poor showing, the company was able to beat expectations thanks to strong revenue performance, particularly in the Corporate Finance and Valuation Advisory segment.
Based on author's own math
Based on my view of the business, I made no changes to my model as my assumptions and outlook remained the same. In fact, the 2Q24 results further solidify my confidence in the assumptions made. The key variable here is whether HLI will trade back to its historical mean of 16x forward PE or continue to sustain the current multiple of 19x forward PE. Being conservative, I continue to model HLI to trade back to 16x. However, I would note that HLI peers like Greenhill (GHL) (2Y forward revenue growth 12%) and PJT Partners (PJT) (forward revenue growth 19%) are trading at more than 19x forward PE, despite having lower 2Y forward growth rates vs. HLI (24% according to my model). So, there is potential for multiples to stay at 19x, which will yield further upside.
Comments
The 2Q24 results consistently reinforce my recommendation to go long HLI. The revenue generated by the Corporate Finance segment, amounting to $282 million, exhibited a sequential growth of 24%. This notable increase strongly indicates that the trajectory of recovery is progressing in a favorable direction. Management further emphasized that there is an improvement in the macroeconomic outlook, as evidenced by the M&A market reaching its lowest point in the spring of 2023. With that being stated, it is worth emphasizing that the potential for near-term growth could exhibit volatility. The rationale behind my view stems from the occurrence of recent macroeconomic events, such as the upward trajectory of interest rate and the presence of geopolitical risks. Management has also indicated that there is an observed elongation of transaction timelines, which I see as a potential indicator of a deceleration in demand. However, it would be premature to dismiss the possibility of further growth, as management also acknowledged that HLI is experiencing robust pipeline and client activities. They noted that M&A dialogues have shown improvement compared to the previous quarters. I maintain a positive outlook on the segment, although I approach it with a degree of cautious optimism.
This increased interest to transact is still tempered by a fickle M&A market resulting in a longer time to close transactions and deeper due-diligence. Source: 2Q24 earnings
The segment that has not yet demonstrated a recovery is the restructuring segment. The restructuring revenue of HLI amounted to $115 million, exhibiting a sequential decline of 7%. My perspective is inclined towards optimism due to the indication from management that the level of activity has demonstrated greater consistency compared to previous periods characterized by sudden spikes followed by declines (which means all of these are expected). I maintain the perspective that an environment characterized by increasing interest rates poses a predominantly adverse impact on numerous businesses that bear debt on their financial statements. In due course, the balance sheets of these businesses will encounter difficulties in accommodating the escalating rates, necessitating a restructuring process. I concur with the management's perspective that restructuring is expected to maintain its robustness in the foreseeable future, as it stands to gain from the anticipated rise in interest rates and the impending maturity of debt obligations.
One potential drawback of the call that investors may express bearish sentiment towards is the limited capital returns. However, my perspective leans towards a more bullish outlook, as I prioritize the long-term sustainability of the business over immediate capital returns. During the current quarter, HLI engaged in the repurchase of 239,000 shares. It is worth noting that the company maintains a cautious stance towards share repurchases, prioritizing the reinforcement of its balance sheet. This strategic decision is advantageous for HLI as it enables the company to capitalize on prospective acquisitions in the future, considering the moderate improvement in the acquisition market compared to previous months. Significantly, management perceives its deal pipeline to be exceptionally strong, leading to the anticipation of a greater number of deals in the upcoming quarters.
Risk & Conclusion
Houlihan Lokey faces significant risks stemming from the potential deterioration of the M&A environment beyond my expectations and the performance of the restructuring business in the current economic cycle. These factors could impact the company's performance and financial results.
If the slowdown in M&A activity persists for a longer duration than originally anticipated, the firm may face challenges. A prolonged downturn in the M&A environment could lead to reduced deal flow, fewer transaction opportunities, and potentially lower fee income. This risk underscores the need for the company to diversify its revenue streams and adapt to changing market conditions. In addition, should the restructuring division fail to meet these expectations due to various factors, including intensified competition, macroeconomic shifts, or regulatory changes, it could result in underperformance.
In light of the recent 2Q24 results and the company's financial performance, the outlook for HLI appears positive. The progress of recovery is evident, particularly in the Corporate Finance segment, which saw remarkable sequential growth. This growth signals a favorable trajectory for the company's future. While the restructuring segment exhibited a sequential decline, management's insights suggest greater consistency and a robust outlook, driven by increasing interest rates and impending debt maturities. However, it's essential to acknowledge the potential for near-term volatility, given macroeconomic factors such as rising interest rates and geopolitical risks. The elongation of transaction timelines and the cautious M&A market contribute to this uncertainty.
For further details see:
Houlihan Lokey: Recovery Is On The Right Track