2023-06-27 02:55:03 ET
Summary
- Revenues declined by 18.1% in Q1 2023 while EBITDA slumped by 35.9% as its specialty healthcare services segment is no longer benefitting from increased demand due to COVID.
- Yet, the engineering, life sciences, and information technology segments are expected to perform well over the coming months.
- I expect EBITDA for the full year to remain above $20 million which would put the valuation of the RCM Technologies at 8.3x EV/EBITDA.
- In my view, the company should be valued at above 10x EV/EBITDA, which translates into $22.02 per share.
Introduction
It's been just over a year since I covered U.S. business and technology solutions provider RCM Technologies (RCMT) on SA. In May 2022, I said that EBITDA for 2022 could surpass $20 million and that the share price could go over $30 by the end of the year.
Well, the financial performance of RCM Technologies surpassed my expectations as EBITDA for 2022 came in at $29.9 million. Yet, the share price peaked at $28 in June 2022, and it stands at $17.95 as of the time of writing. In my view, the company had a weak start to 2023, but I expect EBITDA for the year to remain above $20 million, and considering the market capitalization has declined by 25.6% since my previous article due to share buybacks, I'm now comfortable upgrading my rating on the stock to strong buy. In my view, RCM Technologies looks undervalued based on fundamentals as it's trading at a TTM EV/EBITDA of just 6.4x and a TTM P/E of 8.2x. Let's review.
Overview of the Q1 2023 financial results
In case you're not familiar with RCM Technologies or my earlier coverage, here's a short description of the business. The company was established in 1971 and specializes in the design, development, and delivery of business and technology solutions to commercial and government sectors. The business is split into three operating segments - engineering, life sciences and information technology, and specialty health care services. The specialty health care services division typically accounts for over half of revenues and is involved in the provision of staffing solutions of health care professionals such as nurses, paraprofessionals, and physicians. It also offers teletherapy services and most of its revenues come from school clients. This segment also serves hospitals, and long-term care facilities amongst others. The engineering segment, in turn, specializes in the provision of engineering and design, engineering analysis, technical writing and technical support services, and EPC services across three verticals - energy services, process and industrial, and aerospace. This segment has more than 20 Fortune 500 clients and accounts for about a third of revenues. Its retention rate is about 95%. And finally, the life sciences and information technology segment is involved in the provision of enterprise business solutions, application services, infrastructure solutions, and life sciences solutions. While this segment usually accounts for less than a sixth of revenues, it has the highest gross profit margin - typically over 30%.
Turning our attention to the Q1 2023 financial results of RCM Technologies, I think they were underwhelming as revenues shrank by 18.1% year on year to $67.1 million while EBITDA and net income declined by 35.9% and 41.2% to $5.6 million and $3.8 million, respectively.
RCM Technologies
On a positive note, EPS went to by just 33.9% to $0.41 as RCM Technologies continued to invest the vast majority of its cash flow from operations into share buybacks. In 2022, the company repurchased a total of 1,309,427 shares for $16.5 million (average price of $12.63). In Q1 2023, RCM Technologies bought back another 640,578 shares for $8.2 million (average price of $12.76) (see page 21 here ) and it revealed during its Q1 2023 earnings call that it has repurchased over 1.2 million shares since the start of the year.
RCM Technologies attributed the slow start to the year to project timing and program ramp-up in the engineering segment. Yet, looking through the breakdown of revenues by segment, we can see that the most significant decrease in revenues was in the specialty health care segment. The latter's revenue from school clients declined by 29.4% to $29.3 million and I think the most likely reason for this is decreased demand for nurses following the end of COVID-19 lockdowns. In my view, the entire COVID boost has been lost and it's unlikely this segment will reach quarterly revenues of above $50 million anytime soon. That being said, I expect revenues and margins to remain close to the current levels as RCM Technologies mentioned during its Q1 2023 earnings call that there are shortages of nursing and behavioral health professionals in schools at the moment.
RCM Technologies
In addition, the engineering segment should have an improved performance in Q2 2023 with revenues returning to about $20 million per quarter. In Q1 2023, there was a high level of startup and commissioning work at several job sites in the engineering segment. Looking at the life sciences and information technology unit, RCM Technologies said during its Q1 2023 earnings call that it expects sequential growth each quarter in 2023 thanks to recent managed service wins. In view of this, I'm optimistic that the company's quarterly EBITDA will remain above $5 million, taking the figure for the full year above $20 million.
Turning our attention to the valuation, RCM Technologies had a net debt of $17.9 million as of the end of March 2023, which puts the enterprise value at $166.3 million as of the time of writing. The company is thus trading at a TTM EV/EBITDA of 6.4x. If we assume that the 2023 EBITDA drops to $20 million, this ratio increases to 8.3x. Considering that the financial performance of the specialty healthcare segment seems to be stabilizing and that the other two segments are likely to book improved results over the coming months, I think that RCM Technologies should be trading at above 10x EV/EBITDA. At an annual EBITDA of $20 million, this translates into $22.02 per share. In addition, I expect the company to continue buying back a significant amount of its shares over the coming months, which could boost the share price.
Looking at the risks for the bull case, I think that the major one is that I could be wrong that the specialty health care division has lost all of the boost from the COVID-19 pandemic and its revenues continue declining over the remainder of 2023. Also, it's possible that RCM Technologies is overoptimistic about the performance of the engineering, and life sciences and information technology segments over the coming months. In addition, investors should keep in mind that this is a relatively thinly traded stock, with a daily trading volume rarely exceeding 70,000 shares. There could be significant share price volatility, and it could be challenging to exit a large position.
Investor takeaway
The specialty health care segment of RCM Technologies received a significant boost to its financial performance during the COVID-19 pandemic and the company used a significant portion of its improved operating cash flow for share buybacks. While it seems that this boost is now gone, I expect annual EBITDA to remain above $20 million and this puts the valuation of the company at 8.3x. In my view, there is a decent margin of safety here and the share price could get a boost from further share buybacks.
For further details see:
RCM Technologies: COVID Boost Gone But 2023 EBITDA Expected Above $20 Million