Back in August of 2009, I went through the 3rd quarter results and concluded that the intrinsic value of MHH was between $7-9. I targeted the upper range of $9 but the latest 10-K suggests that MHH is now closer to the lower range of $7.Operational Results
From the 10-K, you can see that revenues declines substantially the past few years.
In 2007, 2008 and 2009, revenues were $104m, $96m and $71m respectively. But rest assured, the decline isn’t due to operational mishaps or bad management.
The first thing to address is that MHH is highly correlated with the economy and job data and there is still uncertainty in the economy. This goes the same for jobs.
When I first looked at MHH, unemployment hit the 9% mark and as of Feb 2010, the national USA unemployment rate is now above 10%. This is clearly out of Mastech’s control and on Wall Street, uncertainty leads to fear. So while the annual report shows an increase in cash, decline in accounts receivables, reduction of debt and positive cash flow, MHH is still well under the radar of any institution to see any stock appreciation for the time being.
The company also sold their brokerage unit for an undisclosed amount to their former vice president of brokerage operations in Jan 2010. From the results, it looks to have been a good move as the brokerage unit saw steep declines (53%) with very limited new orders.
Since the brokerage unit was not a core service to Mastech, I see this as a good sign by the company to cut excess fat. Mastech is lean as it is and it looks like they are going from 10% body fat to 3%.Cost Cutting
Margins were consistent to the prior year but a lot of it had to do with cost cutting.
In Mastech’s line of work, the main capital expenditure comes from personnel and in 2009, headcount for the IT billable consultant department was reduced 20% from 475 to 379. However, the notes regarding the revenue had this to say about the headcount reduction.
Much of this billable headcount decline occurred during the fourth quarter (a loss of 58-consultants) and reflected a high level of project ends….It should be noted that much of the billable headcount declines during the fourth quarter did not fully impact our revenues for that period as much of the decline occurred during the latter part of the quarter. Accordingly, the full impact of this headcount decline will be reflected in our first quarter 2010 results.
From this statement, I know for sure that the first quarter of 2010 will be better than what analysts expect when the savings from the reduced headcount will be recognized.
It’s also important to keep an eye on SG&A and see how expenses are handled.
The reason why I like MHH so much is that despite the tough economy, the company does everything they are supposed to do “by the book”. When times are tough, they cut expenses by freezing bonuses, salaries, hiring, reducing staff, reduce debt, increase cash and so on.
The fundamentals exhibit pure discipline.Tax Rate Changes
It’s a good thing I went through detecting the effect tax has on earnings because MHH is another prime candidate that we can look at.
Remember that MHH is a spinoff from iGate? While MHH was a subsidiary of iGate, they were sheltered by tax benefits and only had to pay about 15% in taxes each year. Now that they are a standalone company, their tax rate has increased to 38.5% and is expected to maintain this level as an independent company.
Thankfully, this isn’t something I didn’t know about. In my initial valuations, I had already taken into account the tax rate but the image below shows that the change in tax rate affected EPS by $0.15 compared to the prior year.
Again, the tax rate change shows that the decline in earnings is not at all related to the operations.2009 Q4 Valuation
Moving on to valuation..
- The basic asset valuation of NCAV is $2.84 which is just more than half the current stock price.
- With declining revenues, higher taxes. My assumption is that the floor for FCF is $2m. Using this figure and projecting a low ball 0% growth rate with a 15% discount rate, the DCF valuation indicates an intrinsic value of $6.70.
- Using an EPS of $0.38 and applying Benjamin Graham’s formula, the intrinsic value comes out to $6.35.
- Applying the EPV method with an adjusted low ball income of $2m the EPV comes out to $7.62 which is also higher than the reproduction cost of $4.50.
Disclosure: Long MHH