2023-08-03 11:40:49 ET
Summary
- Mastech Digital, Inc. reported disappointing Q2 2023 results with non-GAAP EPS of $0.11, missing by $0.04, and revenue of $52.2M, missing by $2.74M.
- Clients are cautious about starting new projects, leading to declining revenues across core segments.
- However, Mastech Digital has expanded into Engineering Staffing Services, which has received positive responses from clients and could diversify the company's portfolio.
Thesis
Aside from its disappointing Q2 2023 report that revealed non-GAAP EPS of $0.11 that missed by $0.04, and revenue of $52.2M that missed by $2.74M, Mastech Digital, Inc. (NYSE: MHH ) still managed to show some promising signs of resilience. Unfortunately, despite an uptick in order bookings and enhanced margins in Data and Analytics Services, the company faces caution from clients in starting new projects and declining revenues across its core segments. While the financial position and foray into Engineering Staffing Services provide a glimmer of hope, this analysis argues that the company's performance and valuation warrant careful consideration, making it a "hold" for investors.
Company Overview
Mastech Digital, Inc., an all-encompassing US provider of digital transformation IT services, operates in two key segments: Data and Analytics Services, and IT Staffing Services.
With offerings ranging from project-focused consulting to comprehensive IT staffing in a host of areas including data management, cloud, and automation, the company has established a broad service spectrum.
The firm has also ventured into the sphere of digital transformation services, thereby modernizing various operational areas of organizations. Serving a vast array of sectors from healthcare to retail, Mastech Digital's diverse clientele underscores its versatility.
Founded in 1986 and headquartered in Pittsburgh, this firm, formerly known as Mastech Holdings, Inc., has successfully cemented its place in the market, highlighting its resilience and long-term market stability.
Mastech Digital's Q2 Earnings Highlights
Mastech Digital, in its Q2 2023 report, has revealed some encouraging signals that may light the way forward, in spite of the trying economic conditions currently gripping its market. One such highlight is the uptick in order bookings, which climbed from $8.4 million in Q1 to $10.1 million in Q2, perhaps suggesting a renewed vigor in business operations and possibly hinting at the potential for a resurgence in the company's activities moving forward.
However, it should be noted that these green shoots in order bookings are juxtaposed against a backdrop of clients who, according to management, are becoming progressively more cautious in kickstarting new projects, a behavior pattern that is likely shaped by the prevalent economic uncertainty. Apparently, the company's pipeline of opportunities is growing, which in an ordinary business climate would signal promising growth potential. Nevertheless, this expansion is seemingly tempered by a slowdown in project initiations, presenting a unique dichotomy.
On an uplifting note, Mastech Digital's Data and Analytics Services segment recorded a 200 basis point enhancement in gross margins. This improvement is chiefly attributed to bolstered utilization rates and superior efficiency in process delivery.
When it comes to its financial standing, Mastech Digital has a cash reserve of $18.6 million, and boasts freedom from the constraints of outstanding bank debt. With a fairly significant borrowing availability of $23.9 million under its revolving credit facility, the company appears to have considerable financial flexibility. Furthermore, the company's day sales measurement stands at a commendable 56 days, falling comfortably below the target range.
In another display of confidence in its long-term outlook, Mastech Digital pressed on with its share repurchase program during Q2 2023. This move not only implies faith in the inherent value of its own stock but also sends a positive signal to the market regarding the firm's outlook.
Lastly, the company has taken an ambitious leap by expanding its horizons into Engineering Staffing Services ('ESS'). This new venture seems to be garnering positive responses from existing clients as well as prospective ones, and could diversify the company's portfolio and help reduce staffing shortages in IT. But like any new initiative, time will tell what its long-term impacts and success may be.
Performance
In the medium-term, Mastech Digital has delivered quite an impressive performance from 2015 to 2023, having almost doubled its share price from $5.46 to $11.22 representing a total growth of around 105%, an impressive feat in just about any investment landscape. If you'd invested $10,000 in MHH in 2015, you'd be looking at a growth of $20,568 by now.
When it comes to comparing this growth with that of the broader market, Mastech's performance appears less stellar. If we use the S&P 500 Index as a proxy for the wider market, we see that it actually outperformed it, posting a total growth of $22,221. What's more, when you include the dividends paid out by the S&P, the total return jumps to $24,418. That's an additional 19% yield on your investment. And in terms of the annualized Rate of Return (ROR), MHH delivered 8.77%, which isn't a bad figure. However, it does lag behind the S&P's 9.76%, even before we factor in dividends. Once dividends are added to the mix, the S&P's compound growth rate jumps to 10.97%, a slight, but nevertheless clear and convincing outperformance of MHH.
Valuation
The blended P/E ratio of 13.20x (see chart below), which is slightly above the normal P/E ratio of 11.69x, gives me pause. The above-average P/E could imply that the stock is overvalued. However, it could also suggest investors expect higher earnings growth in the future, which aligns with the reported adjusted operating earnings growth rate of 12.72%. It's a fairly high growth rate, and if sustained, it could certainly justify the elevated P/E.
Risks & Headwinds
For starters, when you land upon the summary page for Mastech Digital, you've likely noticed the warning , which I believe signifies that the company's EPS has taken a downward turn, coupled with a decelerating momentum that starkly contrasts with the broader sector.
Negative EPS revisions can be, and often are, harbingers of future disappointments and, more often than not, signify internal inefficiencies, potential miscalculations, or worse, declining profitability. Additionally, MHH's 3,6,and 9-month price performance, when contrasted against the sector median, demonstrates that MHH is not only failing to keep up with its peers but is actively regressing in the wrong direction.
Unfortunately, when we circled back to its Q2 results , Mastech Digital certainly provides grounds for more pause and reveals areas of concern that can't be overlooked. The company's revenues experienced a significant slide, showing a 16% decrease on a year-over-year basis, amounting to a total of $52.2 million. The downward pressure is not limited to a single business unit but is broadly felt across both its core segments - Data and Analytics Services and IT Staffing Services.
Zooming in on the Data and Analytics Services segment, revenues were hit by customer cutbacks, falling from $11.2 million in the second quarter of 2022 to a lower $8.8 million in the same period in 2023. Customers, grappling with economic uncertainty, have dialed back resources allocated to existing projects, which has directly fed into the segment's declining revenue figures.
IT Staffing Services didn't fare any better, with its revenues also experiencing a downturn, falling from $50.9 million in Q2 2022 to $43.4 million in Q2 2023. This drop is indicative of softer demand, particularly notable among the financial services clients who are evidently exercising caution in their spending, possibly in anticipation of a potential economic downturn.
Margins too, bore the brunt of these adverse conditions. The company's overall gross margins contracted from 27% in the second quarter of 2022 to 26.1% in the corresponding quarter of 2023. The IT Staffing Services segment was notably impacted, with gross margins shrinking by 110 basis points. This contraction was primarily driven by a decrease in direct hire revenues and an uptick in medical claims associated with the self-insured healthcare program, adding pressure to the segment's profitability.
Lastly, on the net income side, the company recorded a GAAP net loss of $2.2 million or $0.19 per diluted share in Q2 compared with net income of $2.4 million or $0.20 per diluted share earned in Q2 2022 - a key contributor to this turn towards loss territory was an unresolved employment-related claim which necessitated setting aside a $3.1 million pre-tax settlement reserve.
Final Takeaway
Based on the above information, I would rate Mastech Digital a "hold." Despite encouraging signs such as increased order bookings, improved margins in Data and Analytics Services, and a sustainable financial position, the company is facing substantial headwinds. The deceleration in project initiations, recent decline in revenues across core segments, contracting gross margins, and an above-average P/E ratio signal caution. However, the company's demonstrated adaptability and future growth potential in new ventures make it worth retaining for now.
For further details see:
Mastech Digital's Q2 2023 Report: EPS Misses, But Hope Persists