Maximus: U.K. Contract May Continue To Drag Down The Performance

| About: MAXIMUS, Inc. (MMS)
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Exposure and limited improvement in the U.K. HAAS contract may continue to overshadow the business.

Besides HAAS, issues related to other contracts in the U.K. and Australia may also pose challenges.

Amid deteriorating fundamentals and margins, acquiring growth may get difficult.

For the last few years, MAXIMUS (NYSE:MMS), as one of the largest for-profit managers of public social services, has benefited from the privatization initiatives, which is somewhat reflected in the stock that is up more than 140% over last five years, but the changing macro environment is expected to pose challenges that may be too big to overcome in the near future, while the valuation suggests that the market is offering a 'safety trade' premium to the company, banking on the exposure to healthcare services.

The company, providing business process services and technology solutions to government health and human services, e.g. help with enrolment process, independent choice counseling, document processing, data collection & analysis and customer support centers, has clearly benefited from the privatization of the government services, a market that is still developing, even though attracting ever increasing public scrutiny. The trend is backed by the need to improve outcomes, productivity, accuracy, accountability and efficiency for the government-sponsored programs.

Besides acquisitions, revenues, up more than 100% since 2012, over the last few years have benefited from regulatory changes in the U.S., including the Affordable Care Act, and new programs in Australia and the U.K. Lately, much of the Long thesis relied on growth driven by the U.K. HAAS (health assessment advisory service) contract and new work as well as expansion of existing contracts in the U.S., but the recent developments seem to be putting a spanner in the plans.

U.K. Health Assessment Advisory Service contract - a problem spot

The HAAS contract, which started in fiscal 2015, has been the biggest growth driver for the Health Services business, which constitutes more than 50% of the total mix and is growing much faster than the consolidated revenues on an organic basis.

For a while, investors have been concerned about the impact of a slower ramp, weak volumes and reduced contribution from the HAAS contract, especially against high hopes from the contract. Even though the company has recently completed contract modifications, including performance benchmarks, face-to-face assessments and the usual end of contract year modifications, the changes seem to be a case of too little and too late. Reducing revenue guidance and tightening of EPS guidance may have helped only so much. Financially, the last quarter results benefited from a pickup of a few million dollars of out-of-period revenue and income, but the modifications are expected to lower the future revenue run rates.

Considering the importance of the HAAS contract as a growth driver and investors' expectations, the Brexit seems to have added an additional layer of the regulatory risk, which was already increasing for the company in other geographies.

Issues other than HAAS may also continue to pose challenges

Besides the HAAS contract, there are other issues that may continue to act as negative catalysts and top among those issues is the lack of clarity on the Fit-For-Work contract in the U.K. The Fit-For-Work contract that started in the fiscal year 2015 has failed to deliver on the volume front, while the company has incurred costs. Even though the company has repeatedly talked about exploring right sizing or terminating the contract, there is limited evidence to ease the investor concerns. The Australian business is also struggling in terms of volumes, even though the program is profitable.

Financially, margins showing hardly any sign of improvement

Operating margins have continued to be a problem, down from almost 14% during 2013 to the expected 10-12% for the current fiscal year, and looking at the health of most contracts, there is limited evidence to suggest that things may improve significantly from current levels. Expectations for margin improvement rest upon the start­up of the new Jobactive contract in Australia, where the volumes have been below expectations.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.