2023-11-28 18:26:06 ET
Summary
- Maximus’ revenue growth has been impressive, driven by a combination of M&A and organic growth. The company’s backlog and industry relationships are developing well, positioning it well for healthy growth.
- The company’s attractiveness is based on its strong government relationships, allowing Maximus to experience robust organic growth with a lower risk of budgets being cut.
- Maximus is facing a number of growth levers, with the modernization of systems being a critical factor. Given the selective nature of government contracts, we believe Maximus is positioned well.
- The company’s margins have declined consistently, owing to a number of factors. We are not confident of a resurgence, with Maximus now significantly below its peers.
- Maximus’ valuation does suggest some upside, particularly with a FCF yield of >6%. Our concern is that the company’s financial performance is slowing and its relative valuation to its peers is not conclusive.
Investment thesis
Our current investment thesis is:
- Maximus (MMS) is a fairly attractive business. The bullish view of Maximus is based on its commercial characteristics. Strong relationships with the US government agencies have allowed the company to generate consistent new business wins and resilient demand. This positions Maximus well for long-term growth as the Government is unlikely to significantly step back spending, particularly given it has shown an ability to impress sufficiently to win new contracts.
- We are, however, not wholly convinced. M&A has been dilutive, margins have gone from being impressive to underwhelming, and its debt burden is at a level where transformative actions are limited.
- Investors must ask themselves if a ~6% FCF yield alone is sufficient when a portion of this will be used for deleveraging. In our view, we need more given the other uncertainties identified.
Company description
Maximus is a global provider of business process outsourcing ('BPO') services, focusing on government health and human services programs. The company operates as a trusted partner for government agencies, delivering citizen-centric solutions that enhance the effectiveness and efficiency of public programs.
Share price
Maximus’ share price performance has been respectable, returning over 100% to shareholders during the last decade. This is materially below the wider market, reflecting mild financial development despite strong growth.
Financial analysis
Presented above are Maximus' financial results.
Revenue & Commercial Factors
Maximus’ revenue has grown well, with a CAGR of +14% during the last decade. Profitability development has been less impressive, with EBITDA growing at a CAGR of +6% as margins have declined.
Business Model
Maximus secures contracts with government agencies, particularly in the areas of health and human services. These contracts involve outsourcing specific business processes to Maximus, allowing the company to operate programs and deliver services on behalf of the government. Government agencies have generally sought to avoid operating these related/back-end services due to a lack of expertise.
The primary services provided include:
- Health and human services - This can include administering healthcare programs, eligibility assessments for government assistance, managing Medicaid programs, and other services aimed at improving public health and welfare.
- Technology solutions - This may involve developing and implementing software systems to streamline processes, manage data, and enhance efficiency. This is particularly of importance given the rapid development of the technological environment.
- Consulting and advisory services - This involves providing expertise on program design, policy development, and other areas relevant to the programs it manages.
- Workforce services - Involves helping individuals find employment and assisting government agencies in managing workforce development programs. This includes services like job training, career counseling, and job placement.
- Customer service and engagement solutions - This involves interacting with program participants, addressing inquiries, and ensuring a positive experience for those utilizing government services.
Competitive Positioning
We believe the following characteristics are critical to the company’s competitive position:
- Scale - Maximus operates with a significant scale, allowing it to provide global services across numerous departments/agencies and large workforces. This is vitally important when seeking to up/cross-sell.
- Program Integrity and Compliance: Ensuring program integrity and compliance with government regulations is crucial. The company implements measures to prevent fraud, waste, and abuse within the programs it manages, ensuring that government funds are used effectively. For this, the business is well recognized and has a high satisfaction score among clients.
- Long-Term Government Contracts: Securing long-term contracts with government agencies provides Maximus with a stable revenue stream. Multi-year contracts allow the company to plan and invest, without the concern of near-term revenue generation.
- Expertise in Health and Human Services: Maximus’ specialization in health and human services management positions it as a leader in this domain. Its expertise in navigating complex government programs contributes to winning contracts through prior project successes.
- Technological Innovation: Leveraging technology solutions will be a key growth driver in the coming years, as Government agencies seek to modernize their operations and find areas of internal improvement.
- Adaptability to Regulatory Changes: Maximus’ ability to adapt to changes in government policies and regulations is critical. This makes choosing a service provider very selective. Maximus has a strong track record which positively acts in its favor.
Margins
Maximus’ margins have persistently declined during the last decade, although there was a clear acceleration following the pandemic. Management has sought to offset this where possible through reduced S&A spending but this has not been sufficient.
There are a number of reasons for this.
- Firstly, the company has faced increased competition and tightening budgets, contributing to greater pressure to maintain its existing relationships and win new projects.
- Secondly, Management has clearly focused on growth, even if this has come at the cost of unit economics. This can be fruitful long-term if it allows Maximus to develop relationships from which it can upsell and incrementally improve its terms.
- Further, Management has acquired a number of businesses during the last decade, the largest of which being Veterans Evaluation Services, Inc. in 2021. These transactions have contributed to margin dilution, although the expectation is for value to be driven by synergies and commercial enhancement.
- Finally, Maximus has been negatively impacted by the services mix. The company has increasingly provided “cost-plus” services, which are generally lower yielding. This is being offset somewhat by Maximus providing a greater number of short-term contracts.
Quarterly results
Maximus’ recent performance has been robust, although slower than its performance in prior years. Its top-line revenue growth was +8.5%, +2.5%, 5.6%, and +7.0% in its last four quarters. In conjunction with this, margins have stabilized, although do not show evidence of an upward swing toward its pre-pandemic levels.
The resilience of the company’s performance is a reflection of public spending strength currently. Despite uncertain market conditions and the fear of a recession, the US economy is inherently showing strength and is performing far better than its Western counterparts. Further, inflationary pressure on wages has contributed to greater tax receipts, giving the US government and its various agencies greater flexibility.
Further, and more overarchingly, Governments are usually long-term-minded and so are unlikely to see material fluctuations in spending as a result of near-term conditions. As wealth, income, and population grow, the expectation is for spending to follow suit.
Key takeaways from its most recent quarter are:
- The business has divested of another “Outside the US” segment relating to employment services.
- Backlog has reached $20.7b, 4x its TTM revenue.
- US Federal Services, the largest segment, has experienced improvement as a result of volume of VA MDE contracts.
- US Services, the second largest segment, is performing well by converting short-term projects into ongoing contracts, allowing for the initial benefits to margins and subsequent relationships.
Balance sheet & Cash Flows
Maximus is conservatively financed, with a ND/EBITDA ratio of 2.7x. At this level, the business has moderate scope to raise further debt, although Management should now be more focused on driving profitability improvement following successive periods of M&A.
Maximus’ FCF margin has declined in line with profitability. This has reduced the scope for shareholder returns, particularly as its debt obligations grow.
Management’s allocation of shareholder capital has been poor in our view. ROE has declined from an attractive >20% to 10%. This is due to dilutive acquisitions, which have only contributed to growth.
Outlook
Presented above is Wall Street's consensus view on the coming years.
Analysts are forecasting healthy organic growth in the years to come, likely with no M&A, forecasting a CAGR of 5% into FY25F. In conjunction with this, margins are expected to incrementally improve.
We broadly concur with these forecasts. With a weaker balance sheet, M&A is unlikely, forcing the business to rely on organic growth. This is currently showing strength, particularly as backlog continues to grow. Further, we expect Management to focus on margin improvement, contributing to small gains.
Industry analysis
Presented above is a comparison of Maximus' growth and profitability to the average of its industry, as defined by Seeking Alpha (18 companies).
Maximus performs well relative to its peers but is not a standout performer. The company’s growth has outperformed its peers, in part due to M&A, but also its growing relationships with its various segments allowing for new contract wins. Underpinning this is deep expertise and what should be resilient demand.
This said, the company’s weakness is its margins, which are materially below the industry average. We see limited scope for the company to revert to the average, although certainly should close the gap.
Valuation
Maximus is currently trading at 16x LTM EBITDA and 11x NTM EBITDA. This is a premium to its historical average.
Given the margin dilution and dilutive M&A, it would be easy to suggest Maximus is trading incorrectly at a premium to its historical average. This said, the stock was likely undervalued historically, or at least investors expected a dilution to occur. This is why, despite EBITDA only growing by 6%, its NTM EBITDA multiple has broadly traded flat. For this reason, we prefer the NTM FCF yield metric, which suggests the company is at a discount to its historical average.
Further, Maximus is trading at a premium to its peers, both on an LTM EBITDA basis (~29%) and a NTM P/E basis (~27%). This is more difficult to justify and implies investors are heavily weighting towards its scale and vendor relationships. This is an important factor to consider as only 4 of the companies are larger than Maximus. This is an industry where scale is difficult to achieve period, but particularly without margin dilution.
Key risks with our thesis
The risks to our current thesis are:
- Successful win of substantial new government contracts.
- Continued adoption of technology for improved efficiency.
- Government budget constraints impacting contract renewals.
- Failure to adapt to evolving regulatory and technological requirements.
Final thoughts
Maximus is a solid company. It is extremely attractive commercially due to its strong relationships with the US government and robust demand. Looking ahead, we expect growth to be healthy and the importance of its services will limit any cyclicality.
This said, we are not wholly sold on a financial basis. The company’s margins have declined and M&A has been dilutive. This has materially reduced its attractiveness and leaves the business trailing its peers. Despite a FCF yield of ~6%, we do not believe Maximus is a buy yet.
For further details see:
Maximus: Market Leader And Non-Cyclical