Finding Value in Consulting Stocks

Includes: FCN, HURN, NCI
by: Charlie Anderson

The following is an analysis of a few U.S. based national consulting firms.

The Industry

There are some serious pros and some cons to the consulting industry. It is completely based on people, so there is no high-tech equipment to understand in analyzing competitive advantage. Competitive advantage is derived from relationships. A few national firms can create a deep economic moat by having a lot of intelligent consultants who develop long-term relationships with costumers.

Due to these relationships, revenue can also be made more sustainable on a multi-year basis. Operating margins across the industry are between the mid-30s and low 40s. A roof is put on profitability because it is dependent on the consultants. Firms consequently have to spend a fair amount of capital in employee retention.

Another con is the difficulty in determining financial health resulting from the high level of intangible assets (around 60-65% of total assets). The main source of expansion in this industry is M&A. This shows how difficult it is to encroach on new territory, which is, in a sense, good. It illustrates the competitive advantage gained by many firms in this industry.

This is an industry dependent on the overall economy. Some consulting, like that related to mergers and acquisitions, is highly cyclical. The larger firms in this industry can offset this with more dependable income from consulting in restructuring and other fields. The advantage gained from long-term relationships, along with the breadth of experience and economics of scale gained by a large firm, yield some great companies.

The Companies

With all the haste with which the market sells, some bargains have been offered in this industry. I identified three major players:

  • Navigant Consulting (NYSE:NCI)
  • FTI Consulting (NYSE:FCN)
  • Huron Consulting (NASDAQ:HURN)

What immediately throws Huron Consulting out of the stock-picking process is value. I picked this industry because of the values presented by Navigant and FTI, and Huron does not present that value.

I am not worried about any of these three companies as direct competitors to the other two for the reason stated above; each of these companies has long-term relationships with its costumers.

I see upside potential for Navigant and FTI of 65% and 25%, respectively. A good chunk of the revenue in consulting is tied to the business cycle, which isn't at an advantageous stage for these firms right now. The overall pessimism among business has knocked revenue of the 2008 heights for Navigant, but both FTI and Huron have continued to grow the top line straight through the recession due to non-cyclical segments like restructuring.

Despite being 14% [Navigant] and 8% [FTI] off of their recent bottoms, both of these companies still present tremendous fundamental upside. The long-term technical analysis supports this hypothesis.

Disclosure: I am long NCI and I am entering a long FCN positions