2023-03-20 00:31:45 ET
Summary
- Growth has slowed at this company, despite market crushing returns since IPO.
- The potential for recession is the biggest risk the company faced.
- Shares are undervalued, but not deeply enough considering the growth rate.
Mastech Digital, Inc. ( MHH ) is a provider of IT staffing and data and analytics. They were a spinoff in 2008 from IGate, which is a subsidiary of Capgemini ( OTCPK:CAPMF ). The revenue and gross margin breakdown are below:
MHH 10-K 2021
The share price performance since IPO is next up:
dividend channel
This blend of businesses brings margins to lower levels, but the revenue growth and ROIC make up for the margins. Below is the return on capital metrics comparison among peers:
The IT staffing market is estimated to grow at 3.6% to 2028, whereas the data analytics market is projected at 13% growth till the end of the decade.
Company | Revenue 10-Year CAGR | Median 10-Year ROE | Median 10-Year ROIC | EPS 10-Year CAGR | FCF/Share 10-Year CAGR |
MHH | 10.3% | 18.9% | 13.1% | 10.9% | 5.2% |
23.2% | 13.4% | 7.4% | n/a | 25.8 | |
14.5% | 20.3% | 12% | 4.7% | n/a | |
14% | -38.6% | -11.8% | n/a | n/a |
Gross margins have expanded some over the past decade, and operating margins have been relatively stable. They’ve been profitable every year as a public company and only one year of negative free cash flow.
Capital Allocation
MHH pays no dividend and has no active repurchase policy. They’ve made two acquisitions so far and used mostly debt to fund the purchases. It's unclear whether they will use less debt in the future, due to rising rates. Either way I think they have handled M&A responsibly until now.
Future growth will come organically along with more acquisitions. They are still a long ways from returning capital to shareholders, and I hope they maximize their reinvestment runway first.
Risk
The main downside is that potentially growth slows considerably due to macro factors that are out of the company’s control. The devastation to the tech sector, in addition to the fairly widespread expectation of recession has no doubt affected the current growth of the company. Attached to this risk is a concentrated customer base. This is never a great sign, as the broader economic issues could cause significant revenue loss if one of those big customers leave, and again not their own fault. I don’t see execution risk here, the CEO has already proven to be ideal for this role.
Long term debt is at a very low level of $2 million, they have successfully paid down a lot of debt used for previous acquisitions.
One aspect I really like in this story is the high level of insider ownership and having a well-qualified CEO. While the risk mentioned above is real, the rate of ownership shows that incentives should be aligned between investors and management. This level of ownership mitigates the risk to a large extent, and is a great sign for a smaller growth company like this.
Valuation
Shares reached an all-time high in June of 2020 and are now 53% lower than that peak. First we’ll look at the multiples comp followed by the DCF model:
Company | EV/Sales | EV/EBITDA | EV/FCF | P/B | Div Yield |
MHH | 0.6 | 11 | 41.2 | 1.6 | n/a |
DLHC | 1 | 9.2 | 13 | 1.5 | n/a |
BGSF | 0.5 | 7.8 | -47.9 | 1.2 | 5.4% |
JOB | 0.1 | 2.9 | 3.8 | 0.4 | n/a |
money chimp
Because of the mix of segments within the company, multiples aren’t quite as helpful since the peers don’t have the same data and analytics component as MHH. In spite of this, there isn’t any apparent discount when looking at the multiples.
On an intrinsic basis, I used a more conservative estimate of EPS growth. This is to factor in the probability of a recession, which I don't have a definitive call on either way. So using a conservative forecast, the current share price is decently undervalued. Considering the growth rate however, I will be waiting to see if there can be a greater discount offered in the future.
Conclusion
MHH has undoubtedly been a great performer since becoming publicly traded. The biggest going forward is a recession dragging down their growth rate, but either way the company has stability and hasn't been prone to cyclical swings as far as fundamentals go.
Shares are undervalued right now, but for this level of growth I would still like to see more of a discount. It's not hard to see a bright future for this company, and the incentives are in place with a high level of insider ownership, and the CEO is perfectly qualified and has done a commendable job so far.
MHH stock is a hold for me right now, but I like the potential for the longer term.
For further details see:
Mastech Digital: Good Growth At A Decent Price