2023-03-06 08:34:16 ET
Summary
- Expected high single-digit yearly growth ahead, around 75% of projected $2 billion revenues coming from various governmental levels.
- ICF aims to repay its debt and convert the multibillion pipeline into recession-resistant contracts.
- The biggest growth markets are IT modernization, public health, disaster management, utility consulting, and climate environment and infrastructure services.
- ICFI stock outperformed S&P 500 by 35 percentage points.
Investment Thesis
ICF International ( ICFI ) is a unique player in consulting services for governmental agencies on all levels, with a modest international operation. They provide both consulting and technology expertise. With an expected high single-digit/low teens yearly growth ahead, ICF will aim to repay its debt and convert the multi-billion pipeline into recession-resistant contracts. They have increased cash flow and are not shying away from new acquisitions if there is a good opportunity. They are also active in multiple provinces of Canada and in Europe. The new IT-oriented special vehicle will drive the teen digit growth in the most dynamic of their markets.
FY 2022 Results
ICF's fourth quarter was an outstanding finish to 2022, which was a record year for the company across all key financial metrics. The company achieved record contract awards for both the fourth quarter and full year, which resulted in a 12-month book-to-bill ratio of 1.32. I will focus here on GAAP measures. Service revenue increased 15.8% to $1.29 billion , and total revenue was up 14.6% to $1.78 billion. GAAP EPS totaled $3.38 per diluted share and included $24.9 million or $1.31 per share in tax-affected special charges, which primarily consisted of one-off facility charges, severance, and M&A-related costs. The full-year operating cash flow was $162.2 million. ICF ended the year with $556.3 million of debt, a reduction of $145.4 million from the third-quarter debt balance of $701.7 million. This reduction brought the adjusted leverage ratio down to 2.86 at year-end. Paying down the debt, managing interest rate changes and the continuation of both shares buybacks and the dividend (no increase so far, forward yield 0.50%) are the plans for 2023 to bring value for shareholders. The guidance for 2023 is for the service revenue to be in the range of $1.405 billion and $1.465 billion, representing year-on-year growth of 11.6% at the midpoint, implying total revenue of $1.93 billion to $2 billion.
ICF has a track record of consistent revenue and earnings. While the slides for Q4 are not yet available at the time of writing, the deck of November 2022 indicates consistent profitability based on both organic growth and acquisitions. The slides below show non-GAAP EPS CAGR at 10.9%, at the time of the deck publication the GAAP EPS CAGR was 5.6% (number is included in slide not shown here). Moreover, for the full 2022, Operating Cash Flow increased by 47% to $162 million.
Growth Drivers
ICF International is a professional and technological services firm that serves a roster of government clients with social and environmental missions, energy utilities, and commercial clients. The majority of their revenues (75%) comes from governmental clients (including 7 percentage points from non-US governmental clients). The biggest growth markets are IT modernization, public health, disaster management, utility consulting, and climate environment and infrastructure services which accounted for approximately 55% of the service revenue at the end of 2020 but grew to 75% as of the end of 2022. Three major acquisitions over the last 3 years have started already to contribute to the revenue growth.
The most recent deck from Q3 presents the distribution of these contracts per domain and per governmental (mostly US) agencies. The largest client is the Department of Health and Human Services.
Let me pinpoint the key strengths of ICF per each market area. In the IT modernization service, ICF is a recognized leader in the most widely used low-code / no-code and open-source platforms (30+ platforms) in the federal government. This business segment has been aided by buying SemanticBits, a provider of agile software development and digital transformation services to key U.S. federal health agencies, now accounting for the key revenue bits from the Centers for Medicare and Medicaid Services ("CMS"). As mentioned above, HHS is the biggest client of ICF, hence the 11% budget increase at HHS for FY22 was a major tailwind for the company as well. Moreover, ICF launched ICF Next, a go-to-market brand for digital and engagement services, to be led by Mark Lee as Chief Technology Executive.
In disaster management, ICF has a long track record of managing post-disaster federally funded recovery programs, currently running disaster recovery programs in 20+ states and territories.
For energy efficiency and utility consulting, ICF is one of the largest full-service climate consulting practices in the U.S., with additional expertise in adjacent services closely connected to climate and infrastructure. As such, the 2021 Infrastructure Investment and Jobs Act ('IIJA') with its FY 2022 federal budget focusing on climate change mitigation, environmental stewardship, and infrastructure, as well as the Inflation Reduction Act of 2022 ('IRA') provides significant climate and energy-related opportunities. Even though the infrastructure developments experience delays in the connection to the grid, the management, as stated in the last Q4 earnings call , does not see any slowing in the demand for consultative services associated with the energy sector projects. On this plane, the acquisition of Blanton & Associates, an environmental consulting firm providing a broad range of environmental consulting, permitting, and planning services in Texas, strengthens ICF's presence in a state that is set to receive significant federal investment dollars under the IIJA.
See below examples of flagship projects that ICF presented to the investors' community last November.
Overall, ICF ended 2022 with a business development pipeline of over $8.5 billion, 20% higher than 1 year ago, in part due to revenue synergy opportunities related to the 2 larger acquisitions completed in 2022. The management's goal is to achieve high single-digit organic service revenue growth through 2024, driven by the abovementioned 5 key growth areas wherever ripe for a double-digit total revenue growth (e.g. IT services have been growing at a CAGR of 15% for a couple of last years), not excluding possibilities of adding acquisitions that are a strong cultural fit and offer revenue and earnings synergies.
Considering this strong foothold in the governmental agencies and plugging into the huge appropriations makes the company nearly recession-proof, in the eyes of the management.
Risks
Major risks that the analysts asked about related to the interest coverage and hedging of the rate hikes. The fourth quarter interest expense was $9.2 million, $6.8 million above last year's level, reflecting both the higher debt balances related to the recent acquisitions and higher interest rates. ICF manages, however, to offset a significant portion of its higher interest expense through various cost reduction initiatives, including lower facility costs, managing other non-direct billable expenses, and executing tax efficiency strategies.
Technical Analysis
Explanation of My Technical Analysis Toolbox
I will analyze ICF from a perspective of a number of technical analysis tools and show the screenshots on the monthly and weekly Heikin Ashi candles charts - each timeframe presented through two separate sets of indicators - which I will complement with a simplified daily Renko chart to reflect the short-term price momentum
The first chart setup (I will call it Chart 1) uses Bill William's Alligator indicator and Awesome Oscillator, as well as Ichimoku Clouds and On Balance Volume indicator line. For fundamentals, I show the quarterly revenue trend which I use for quick visual triage.
The Alligator technical analysis tool uses three smoothed moving averages that are based on thirteen, eight, and five periods, called also Jaw (blue line), Teeth (red line), and Lips (green line), respectively. Due to the smoothing of each moving average, the Jaw makes the slowest turns and the Lips make the fastest turns. The Lips crossing down through the other lines signals a short opportunity while crossing upward signals a buying opportunity.
William's Awesome Oscillator ('AO') is a market momentum tool that visualizes a histogram of two moving averages, calculated on median prices of a recent number of periods compared to the momentum of a larger number of previous periods. If the AO histogram is crossing above the zero line, that's indicative of bullish momentum. Conversely, when it crosses below zero, it may indicate bearish momentum.
As for the Ichimoku Cloud - I am not using a full set of lines of Ichimoku lines, only the Leading Spans A and B, whose crosses dictates the color of the cloud and whose individual lines provide levels of the strongest support and resistance lines. Ichimoku averages are plotted into the future which in its own right provides a clearer picture but have no predictive powers.
On-Balance-Volume ('OBV') indicator is a volume-based tool and is supposed to indicate the crowd sentiment about the price. OBV provides a running total of an asset's trading volume and indicates whether this volume is flowing in or out, especially when viewed in divergence with the price action.
The second chart setting (Chart 2) uses 2 moving averages (10- and 50-period), volume, and volume's 20-period average. On the screenshot from top to bottom, you will see the Composite Index Divergence Indicator ('CIDI'), which I learned from the book of Constance Brown, as well as J. Welles Wilder's Directional Movement Indicator (DMI). I also use MACD (Moving Average Convergence Divergence) which is well known to everybody: I seek crossovers of MACD and signal, as well as above/below the zero level.
CIDI comes from a combination of RSI with the Momentum indicator. For more literature, see Brown's paper or read her book. CIDI has been developed to solve the problem of RSI not being able to show divergence. I personally use the CIDI's crossover above and below its slow and fast-moving averages, as well as the position of the averages against each other.
As for DMI, I skip the ADX line because it doesn't give me anything. Instead, I focus on the crossovers of the Positive Direction Indicator DI+ and Negative Direction Indicator DI-. When the DI+ is above DI-, the current price momentum is upwards. When the DI- is above DI+, the current price momentum is downwards.
On the use of Heikin Ashi candles and Renko boxes, I use them as tools for trend reversal and continuation identification. Renko charts do not have a time scale and they are built on price movements that must be big enough to create a new box or brick. Similar to Heikin Ashi, Renko charts filter the noise.
The Long-Term Trend
For the long-term trend analysis, I use monthly charts. As we see in Chart 1, March has been marked so far as a new green Heiking Ashi candle. If it remains like this, now could be the beginning of the upward swing. AO is still red but remains in the positive territory despite the pullback of the preceding 3 months. OBV is directed upwards the general slope of this line is positive, the same as the Ichimoku Cloud whose upper edge has risen. All the Alligator's lines are trending up.
In Chart 2 we see that CIDI has bounced from the recent bottom and is approaching its fast (green line) moving average. Possibly in the next 2-3 months, the fast average will also make a U-turn and rise. The monthly MACD has flattened and is approaching its signal to cross it from below. DI+ is above DI- and is directed upwards. If we look at the S/R lines I drew on the levels $85, $95, and $108, we can observe that the stock has moved from the lower range to the higher one and the next S/R may be established around $120, near the all-time high from November 2022.
The Mid-Term Trend
For the mid-term trend analysis, I use weekly charts. As we can see in Chart 1, the S/R lines which I drew on the monthly scale, are pretty much consistent with the upper and lower edges of the recent Ichimoku Cloud on the weekly scale. The positive turns are visible in the rising of the edges of the green Cloud. The lines of the Alligator are currently at the stage of the important crosses: green (Lips) is crossing red (Teeth) and blue (Jaw), and the red one is crossing the blue one. The weekly AO has arrived to the zero level - I would expect it to turn positive next week. The OBV line is recovering from the lows at end of the last year.
For Chart 2, I zoomed in on it more than usual. We can appreciate the appearance of at least 4 technical indicators giving positive readings. The 10-week Moving Average is just now bouncing off the 50-week MA. CIDI is above both averages and the fast one (green line) is making an upturn, possibly to cross the slow average from below. MACD is just now on the verge of crossing above its signal on the almost exact zero level, visually bouncing off zero. Last but not least, DI+ has just crossed above DI-.
Price Momentum
The Renko chart with a daily scale indicates a high probability start of momentum. We see a new green box being drawn on top of the chain of three preceding green boxes since mid-February. The 10-box MA is above the 50-box MA and MACD is approaching its signal from below. I believe at least two more boxes would be needed because this will mark leveling with the all-time high and this could become a breakout moment. However, we do not know when it will happen since the Renko chart is not scaled on the timeline.
Conclusions
ICF International could be an international addition to a portfolio for somebody who wants to exploit the power of government contracts and the investment going to huge structural changes in basically each major policy area. Many consulting companies are not publicly traded, thus they do not allow to profit from their access to public funding with multi-year invoices. Moreover, for the last 12 months, ICF outperformed the broad market by nearly 35 percentage points which in itself plays interestingly into market hedging or relative outperformance interests.
For further details see:
ICF International Banks On Big Government Contracts, Recession Comes Or Not (Technical Analysis)