2023-10-31 23:25:45 ET
Summary
- Hackett’s revenue has grown at a CAGR of 4%, owing to positive industry tailwinds being partially offset by high competition.
- The company has achieved an impressive improvement in margins, owing to a repositioning strategy to focus on recurring revenue / high-margin services.
- We believe margin improvement is sustainable, although it is not clear if revenue growth will improve, given that economic weakness is weighing on the company.
- HCKT is trading at a NTM FCF yield of 7.6% and a small premium to its historical average NTM EBITDA multiple, implying upside.
Investment thesis
Our current investment thesis is:
- Hackett’s repositioning exercise has differentiated the business well, while significantly enhancing its business model. The benchmarking-consulting cross-selling has shown itself to be impressive already, with greater recurring revenue services positioned well to enhance this. At a minimum, we believe margins above its FY19 level are sustainable, with scope for slightly better growth.
- There are risks associated with increased competition eroding its competitive advantage, although we believe its strong development at least provides medium-term protection. At a substantial discount to its peers and a FCF yield of 7.6%, we consider this stock attractively priced.
Company description
The Hackett Group, Inc. ( HCKT ) is a global strategic business advisory and operations improvement consulting firm. The company is headquartered in Miami, Florida, and operates internationally, serving clients across various industries.
Share price
HCKT’s share price performance has been impressive, with over 200% gains and a large positive delta to the wider market. This is a reflection of its positive financial development and strategic repositioning.
Financial analysis
The Hackett Group financials (Capital IQ)
Presented above are HCKT's financial results.
Revenue & Commercial Factors
HCKT’s revenue has grown at a CAGR of 4% during the last decade, with broadly consistent gains offset by periodic drawdowns.
Business Model
HCKT specializes in business consulting, with a focus on helping organizations improve their performance. They offer a wide range of consulting services aimed at optimizing various business functions, including finance, procurement, HR, IT, and supply chain management.
The primary objective is to help clients streamline operations, reduce costs, and enhance efficiency. Unlike some of its peers, the company does not just stress “transformation” as its expertise but as a provider of support across the operating spectrum.
HCKT also assists clients in defining and implementing performance metrics and key performance indicators (KPIs) that align with their strategic objectives. This helps organizations track progress and make data-driven decisions. This is perfectly positioned alongside HCKT’s other services.
A key component of HCKT's business model is benchmarking. They provide clients with access to extensive benchmarking databases and best practice research. This allows organizations to compare their performance against industry peers and identify areas for improvement. This provides the company with recurring revenue, supporting what can be volatile consulting revenue.
Furthermore, this represents a strong opportunity to cross-sell services, with its benchmarking services representing a quality marketing opportunity (and vice-versa). Currently, 60% of its revenue comes from customers previously enrolled in its Benchmarking offering while 25% of revenue is from customers who were previously Consulting clients. It is clear that the opportunity for this is high, representing an opportunity to further bolt-on services in our view.
HCKT is increasingly advising on the selection and implementation of technology solutions that support business process improvements. It provides insight into emerging technologies and their potential impact on operations. This is driven by the digitalization of all aspects of society, contributing to a growing use case for technology within both front and back-office operations to improve efficiency. Three of the 4 boxes on the company’s website landing page are data/technology related.
Management believes there are opportunities to improve its financial performance through its investment in intellectual property, allowing for even greater cross-benefits between revenue streams and importantly, improved margins. Further, this should allow for greater recurring revenue through IPaaS, syndicate IP, market intelligence insight, and executive advisory/research, reducing its dependency on consulting works as a means of generating business.
Consulting Industry
The Hackett Group competes with other consulting firms, including large global players like Accenture, Deloitte (and other B4), and McKinsey, as well as specialized firms that focus on specific industries or consulting areas.
We believe the consulting industry, and in particular, the segments HCKT targets is positioned well to achieve growth in the coming years.
- Competition - In an increasingly competitive business landscape driven by globalization, corporates are constantly seeking ways to operate more efficiently. This has been exacerbated by the digital revolution, making operations far more complex, and contributing to demand for support. It has almost become standard for SMEs and beyond regularly utilizing consulting services in some form.
- Digital Transformation - The digital age has prompted corporates to reevaluate their operations and adopt digital technologies, particularly due to the standardization of these services. They began as specifically targeted and expensive, now transitioning to being far more universally available. We believe Cloud computing and AI are key growth areas in the coming years, with HCKT positioned to benefit. Underpinning this will be continued demand for ERP/EPM implementation.
- Data-Driven Decision-Making - With technological development and the digitalization of society, the importance of data analytics has grown rapidly. It has the potential to improve efficiency through benchmarking but also customer acquisition.
- Management Expertise - Successful transformations require not only process improvements but also the buy-in and engagement of employees. Unlike many of its peers, HCKT supports with developing management expertise to ensure a company’s employees are operating and being led in an efficient manner.
- Talent Pool and Acquisitions - Attracting and retaining top consulting talent is essential to providing high-quality services and achieving growth. We believe this has been an area of weakness for the company, limiting the development of its clientele. Additionally, many of its peers have acquired boutiques to supplement growth, which is a strategy HCKT has also avoided.
Margins
HCKT’s margins have impressively improved in recent years, benefiting from a post-pandemic surge in demand, as well as a shift in product mix toward IP and other high-margin services (executive advisory and market intelligence offerings). Given the consistent shift toward these services and the specific focus by Management, we believe these elevated margins are likely sustainable. The key is that they are built on quality IP that its clients have shown a willingness to pay on a recurring basis.
Quarterly results
HCKT has experienced a noticeable slowdown in recent quarters, with revenue growth of (0.6)%, (1.4)%, (7.0)%, and 1.2% in the last 4 quarters. Despite this, margins have been broadly consistent, with the LTM only down 1ppt at an EBITDA-M vs. FY22, illustrating the strong foundations for maintaining this level.
The key takeaways from Q2 are:
- Revenue growth of 1.2% was above Management’s high-end estimate, implying an unexpected improvement in growth. This could be evidence of a reversal of the revenue trend.
- Investment in program development and sales resources continues as a means of growing its recurring revenue / margin services further.
- Economic headwinds are being felt, with the belief that there is softening corporate spending on consulting services. Its size and relative brand values make it difficult to operate a robust revenue profile during periods such as this (larger peers will have a significant backlog/WIP to rely on).
- Management ended its views with the following quote, implying strong positivity “ More importantly, the current momentum is expected to continue into the third quarter and bodes well for the balance of the year. ”
Balance sheet & Cash Flows
HCKT’s FCF has improved alongside margins, contributing to highly lucrative returns for the business. With limited debt usage, these cash flows can be directly funneled to shareholders, with substantial buybacks during the LTM period. At a market cap of c.$700m and an LTM buyback of c.$118m, the yield has the potential to be substantial if this approach is continued.
Outlook
Presented above is Wall Street's consensus view on the coming 5 years.
Analysts are forecasting a continuation of its current growth rate, with a CAGR of 4% into FY24F. In conjunction with this, margins are expected to decline slightly, although broadly remain flat.
This appears reasonable in our view. We do see scope for improved growth within various industries (such as tech), as well as expansion of its recurring revenue services, although HCKT’s performance thus far implies competition is restrictive and economic conditions are muddying its true performance.
Industry analysis
IT Consulting and Other Services Stocks (Seeking Alpha)
Presented above is a comparison of HCKT's growth and profitability to the average of its industry, as defined by Seeking Alpha (21 companies).
HCKT performs modestly relative to its peers. The company has struggled to match the industry’s growth, with this weakness expected to continue in the coming year. This is a reflection of HCKT’s competitive positioning, lacking the expertise and brand value to take market share from its larger peers.
The company’s key area of strength is its margins, with a substantial premium to its peer group. This does shrink when considering FCF/ROE. This reflects HCKT’s approach to transitioning the business model toward recurring services with higher margins, as its FY19 EBITDA-M would be average.
Valuation
HCKT is currently trading at 11x LTM EBITDA and 10x NTM EBITDA. This is a discount to its historical average on an LTM basis. Interestingly, the company is directionally contradictory between LTM/NTM, reflecting the slowdown in revenue growth during the last few quarters.
Our view is that a small premium to its historical average is warranted, owing to the improvement in margins but the lack of clear commercial development on the consulting side. At its current valuation, we see upside, with a weighting toward the more conservative NTM metric.
Further, HCKT is trading at a discount to its peers, which we consider appropriate. Despite HCKT’s impressive margins, it has been unable to consistently achieve industry-average growth, suggesting commercial weakness. Further, the nature of the industry means margins will always be threatened. The discount appears large, as our suggestion would be closer to c.20%.
Final thoughts
HCKT is a solid business that has smarty repositioned itself to enhance returns. Although growth has been mediocre, we are highly positive about its expansion of IP, allowing for margin improvement. This has remained consistent in FY21 and during the current economic difficulty, suggesting resilience.
It remains unclear if revenue growth can consistently improve but with improved margins alone and a FCF yield of 7.6%, we consider the stock a soft buy.
For further details see:
The Hackett Group: Recurring Revenue And High Margins, Valuation Implying Upside