Barrett Business Services: Its Second Sweet Spot

| About: Barrett Business (BBSI)

Barrett Business Services (NASDAQ:BBSI) has racked up a 40% share price increase since December validating it has indeed found a sweet spot. Now it's found a second. Barrett Business is primarily a PEO, a professional employer organization. A PEO assumes responsibility for some or all of the client's human resource management responsibilities. Barrett, as well, provides HRO (human resource outsourcing), recruiting and staffing services. This breadth and depth is what makes Barrett's position in the industry a sweet spot.

In its quarterly reporting on April 23rd, Barrett touted its fifth consecutive quarter of greater than 30% revenue growth with the first quarter tallying 37%. It projected second quarter revenue growth of at least 28%. Such staggering rates make it comfortable to rely on the long-term EPS growth rates of 35% annually from analysts.

The first quarter of each year, Barrett typically experiences a loss due to higher payroll taxes. The loss for the 2013 first quarter was $0.36 compared to 2012's loss of $0.22. At first glance, this looks problematic and the share price did pull back as much as 10% on the news. However, the loss for 2013 was magnified by the decrease in shares outstanding. Barrett repurchased 3 million shares in the first quarter of 2013. Had the shares outstanding count stayed steady, the loss would have been $0.26 instead of $0.36. Still, fewer shares outstanding is a good thing for shareholder value. The loss should be viewed in context.

Investors may wonder if the opportunity to capitalize on Barrett's growth has passed. Consider Barrett's target market consists of small businesses with 20 to 500 employees. According to the Small Business Administration, there were 556,900 companies in that target market effective 2010. In March 2013, Barrett had 2,350 clients, not even 1/2% of its target market. In the first quarter of 2013, Barrett experienced the greatest client build in its history, adding a net 198 clients.

Barrett boasts a 90% retention rate of its clients. Barrett credits that success rate, in part, to having branches in close proximity of its clients. So, another factor of note is that Barrett has offices in only 10 states. The strategy of the locations does allow it to do business in 23 states. Yet, the numbers depict well the penetration potential still available for Barrett.

In the first quarter conference call, the CFO Jim Miller and CEO Mike Elich enlightened analysts on the status of Barrett's growth plans. Jim Miller stated,

"We will continue to prudently invest in our operational infrastructure and professional talent throughout 2013".

CEO Mike Elich added,

"We continue to see strength in our growing pipeline and we will continue to mature the organization as we build to our future."

He also explained,

"Our primary obstacle to growth is how far we have built in front of our demand which is where we are consistently putting a great deal of effort, attention and effort investing back in the infrastructure."

"We remain ahead of plan and align the organization to support a growth curve and we'll continue to make the necessary investment in the infrastructure to stay out in front."

Its cash and equivalents position of $78.3 million aids in those endeavors. With only $5 million in long-term debt, Barrett is postured well to continue advancing into new territories. Additional factors supporting the ability to grow geographically are new processes and procedures. CEO Mike Elich described the adoption,

"The thing that we didn't have a year ago that we have today is because of the branch within branch philosophy we have the incubator in a sense that is allowing us to mature talent so we can now transfer culture. The problem that we had before is is to be able to go and follow a customer to a new market, we didn't have the capacity to be able to say, this person could go to this market and leave their branch or leave their customer base without wrecking that customer base. Today we have a model that allows for sustainability of our current business and the current customer base while we would expand to those markets."

Increasing revenues is not the only area Barrett is addressing. To protect margin rates, Barrett reviewed its pricing structures in 2012. From the conference call:

"And also where we were from a cost standpoint post-recession, is we did go back into our client base and increased current prices somewhat across the board."

Even with 40% appreciation, Barrett's share price is still undervalued based on its long-term EPS growth estimate of 35%. With 2014 estimates at $2.91, its YPEG now equates to $98.70. Banking on such an aggressive growth rate may rightfully be difficult for some investors. But, remember the company's revenue projections for the second quarter of $630 to $635 million represents a 28% year-over-year increase. Barrett has a strong pipeline in place. Its market penetration is still low. Its customer retention rate is high. Barrett management is focused on its growth curve and how to stay ahead.

Barrett has found a sweet spot in the services industry. While it may appear that Barrett's stock price is ahead of itself, the beauty is that Barrett is ahead of its growth. And that's a pretty sweet spot as well.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BBSI over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I plan to recommend BBSI to my investment club at the May meeting.