CRA International: A Hidden Gem In The Consulting Industry

Summary

• The company missed estimates, however, the outlook from the management is looking promising.
• The company seems to be resilient to downturns over the years, however, it doesn’t mean it is invincible.
• If the company manages to achieve better efficiency, the company could be a good long-term hold.
• A DCF valuation shows the company is good at producing FCF, however, conservative estimates of margin expansions and revenues suggest the company is at a fair price.

VioletaStoimenova

Investment Thesis

CRA International's (NASDAQ:CRAI) results, although missing expectations slightly, were not the worst in my opinion with around a 7% guidance for '23 and potential profitability margin expansion. I decided to look into it to see how well it can perform in the next 10 years with moderate revenue increases and promising reductions in costs that would make the company more profitable and potentially reward shareholders. With certain assumptions in place and a bit of a pessimistic take on the management's ability to deliver, and the uncertainty of the global economy, the company is a hold for now until we see what will happen in the next couple of quarters in terms of margin expansions and free cash flow generation.

The Company and FY2022 Results

CRA International is a global consulting firm, that specializes in litigation, regulatory, financial, and management consulting. What they do is provide economic and financial analysis in litigation and regulatory proceedings, and guide businesses through critical strategy and any other operation issues they might have.

The results for the year as I mentioned were not the worst, but they did miss expectations slightly. Revenue came in at $590m, which indicates a 4% increase y-o-y. Gross margin has seen a slight expansion from the previous year of around 1.3% while operating margins have decreased by around 1.2% which negates the gross margin increase. The company added 9% to its workforce also. The management provided a '23 revenue outlook to be at around $615m to $640m which at the midpoint stands at a revenue growth of around 7% y-o-y.

Potential Outlook of Revenue and Margins

In this section, I will look at what potential growth the company may have that could contribute positively to the growth and what kind of setbacks may appear in the future which would warrant a discount on growth in my model.

The M&A sector globally has seen a very large decrease, going down by a whopping 37% y-o-y according to Reuters, which affected their revenue because around a fifth of the company's revenues comes from that sector, particularly from antitrust and competition economics practice.

The decrease in activity is the largest seen in a while, however, the sector is poised to rebound slightly in the 2nd quarter. I think much is uncertain as it's all just predictions, and with further collapses in the financial industry, I would assume a lot of companies may be very cautious in approaching some merger deals that could potentially fail. For this revenue segment, I would be cautious in giving it good growth prospects in the beginning, but it should have better performance in the future.

To offset that segment of revenue, the regulatory environment across the globe is becoming stricter with much more regulations becoming the norm, due to the same reason: the potential collapsing of financial institutions that are not able to withstand stress tests, and there could be much more regulation coming. The company will likely keep seeing the demand for its services increase here and will likely play a relatively large role in revenue growth in the future. The more regulations will be put in place to avoid any big collapses in finance and other sectors, the more revenue the company should be able to reap.

Margins

Other contributors to more revenue would be the way the company is hiring. With a 9% increase in workforce y-o-y, they look to be growing strong and not being bothered by what is happening in the economy, with more companies announcing layoffs on what seems like a daily basis. This could be a double-edged sword in my opinion, just like many companies in the past went on a hiring frenzy because they thought the demand for their services was going to explode, only to be proven wrong and start firing left and right to get back to better margins and profitability. The same can be true for CRAI. It seems that the management does not foresee any major downturns in the economy and believes that the new hires will bring in positive NPV in the future and will be able to keep them on for the long run.

As I mentioned before, they were able to improve their margins slightly y-o-y and they are aiming to improve their SG&A margins further to a baseline of around 15.5% to 16% of revenues in '23. How likely this will happen will depend on many factors, however, I believe the management has some decent forecasting ability in such a short-term time period. I also do not know if their forecasts have a recessionary period built in which could affect their financial results in the short run. I haven't seen any forecasts for increasing gross margins, but it has stayed relatively stable over the last 5 years. It is right now at around the same levels that the company saw in 2018.

In terms of resiliency, the company has been quite strong during the recent major downturns and showed strong revenue growth over the last 13 years. An important thing to note is that the only time the company saw a large decrease in revenues was after the '08 crisis, and the revenue decline continued until 2010, which coincides with the highest unemployment rate in recent history, not counting the pandemic temporary unemployment rates. I would predict that if we do see some sort of a tick-up in unemployment, the company's revenues will also tick down slightly.

Revenue growth (Seeking Alpha)

Overall, the company's mix of consulting revenue segments seems to be performing quite well in a lot of different economic environments which demands a little less discount on the future cash flows that the company will be able to generate and if the management can achieve better margins, then the company can be a great investment in the long run, in my view.

Briefly on Financials

In terms of liquidity, the company could be in a better position but the fact that they have paid off their debts and have a decent amount of cash on hand is a good sign. The management seems to know what they're doing and should be able to continue to award shareholders through dividends and share repurchases in the future, without the need to employ debt. With that said I do wish that their current ratio was much higher than it is right now. It's been fluctuating between being able to pay off their short-term obligations to not and right now they are just barely able to. It is a bare minimum I accept a company to have, and I would like to see a company getting closer to 2.0, as to me that is a good measure of liquidity.

Current Ratio (Own Calculations)

Where the company does seem to shine is how it is using its capital and shareholders' capital in the last 5 years. The company was able to invest in some great projects which now nets them very good ROIC, ROA, and ROE figures. The management is efficient in creating much more value than the capital requirements of the projects.

ROI ROA and ROE of CRAI (Own Calculations)

Overall, decent books with good metrics, but liquidity measures can be improved and hopefully will improve. I'll keep a close watch on future earnings calls.

Competition Comparisons

Let's have a look at how CRAI is compared to some competition. In terms of P/E, the company is the lowest out of the competition and has been in this range for a while now. It has traded at around 24 for a short while then dropped to around 15 at some point, so it seems like it is trading at decent multiples right now.

PE Comps (Seeking Alpha)

EV/EBITDA ratio is also much more attractive compared to the same competitors which could indicate the company might be a good investment.

EV/EBITDA Comps (Seeking Alpha)

SG&A margin sits at a middle point of the comparison, and if the company succeeds in bringing it down to 15.5% to 16% it will be even more attractive compared to the competition.

SG&A Comps (Seeking Alpha)

Valuation

The above evaluation of the company's prospects and the negative sentiment in the global economy leaves me with no choice but to take a conservative approach to growth assumptions. Another reason I like to be conservative is that that's just how I am and would rather be on the safer side than overpay for what seems to be a good company that is capable of generating good cash flows in the future and rewarding its shareholders.

The biggest drivers for the company in my opinion would be if the management can make the company more efficient in terms of expanding profit margins. The management is looking into reducing SG&A percentage by around 200bps in one year, which would be the base going forward. To take a more conservative approach, I will linearly grow it down to 15.5% over 10 years, which suggests the company is going to become more efficient but not that quickly due to some unforeseen obstacles that are hard to put a number on.

The cost of services has been fluctuating also quite a bit in the last 5 years, but in my model, I will have the cost of services, or the gross margin improve also slightly over the next 10 years in a linear fashion and improve by around 140bps. These figures are in the base case scenario, and for the optimistic case the efficiencies are 50bps better, and for the conservative case 50bps worse.

With the main drivers accounted for, I will go with a simple revenue model that decreases the growth over time too. Right now, for my base case, I assume a 4% revenue growth over 10 years, 2% for the conservative case, and 6% for the optimistic case.

These already look like pretty conservative estimations, but to test the company further, I like to add a 25% margin of safety on the intrinsic value. With all in place, the intrinsic value of the company right now is $105.33 implying that the company is priced almost at a fair valuation if you believe these estimates.

10-Year DCF of CRAI (Own Calculations)

The Takeaway

The company seems to be in a good position to perform well in the future, even with what I would consider quite beaten-down estimates. The company looks close to a fair price right now and the only thing that would prevent me from investing in this, or any other company that I have recently covered, is that none of them screamed to me as an actual undervalued company when taking into account the uncertainties in the economy, and the same thing goes for this company. These estimates consider the uncertainty in the economy, which undoubtedly will bring down many stocks in the future if we do see a downturn in the next 6-12 months and so I will wait patiently while observing how the economy unveils itself. There are some positive signs coming in already, with inflation coming down, although likely not at the rate the Fed would like.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.