Investment Thesis
Barrett Business Services is a provider of payroll and
administrative services as well as professional employment services to small
and mid-sized businesses. It is based in
Vancouver WA and has the majority of its current business in the West (CA, OR, UT,
WA, CO, ID, AZ, NV, and recently NM) and a smaller base in the East (MD, NC, PA, DE, VA.) A number of important factors are behind why
BBSI is a relatively safe and potentially very good investment in the 1-3 year
time horizon. Growth and multiple
expansion are both possible for this small-cap with an excellent balance sheet,
solid normalized earnings, and a checkered past.
As it has done in the recent past, BBSI has plunged in price and is certainly still in value-stock territory at the time of this writing, despite a significant rise from recent lows. It is an understatement to say that BBSI’s share price has been on a roller-coaster ride over the past 6 years. Three times over that period it has reached into the high $90’s only to fall back under the cloud of issues that sent the share price plummeting. Workers' compensation reserve issues, accounting irregularities, and most recently the Covid-19 pandemic provided the drivers for these pullbacks. The recent low of $27 was reached during the point of maximum market uncertainly in March of 2020. As was the case for many companies, an entry at that point would have provided an investor with an attractive return even against today’s price in the low $50s.
Although many companies have managed to return to pre-pandemic levels, this write-up explains why I believe an investment in BBSI in the $50-55 range provides an excellent margin of safety and could yield a 3-year annualized return of up to 10-30% not including the current annual dividend yield of 2.25%.
BBSI has been written up multiple times on Seeking Alpha and
Value Investors Club. In most cases, the
main theme of these articles has been its low P/E multiple and expected strong
recovery due to a solid business model and continued growth. With such a large number of articles
available, I will refer readers to the better of these articles and discuss the
support of my investment thesis. I
believe the excellent work by tim321 posted on January 19th,
2018 on VIC (here)
provides the clearest and most comprehensive look at BBSI. Despite the negative return since that publication
2.5 years ago, there is no issue with the premise presented in tim321’s article.
With the exception of potentially rising
interest rates, the author’s projections for revenue, EPS, and resulting share
price were accurate and actually exceeded by BBSI.
However, the impact of a much-anticipated recession at the
end of 2019 followed by the Covid-19 pandemic delivered the stock price a one,
two blow that has landed it in value territory once again. Due to the massive uncertainty surrounding
BBSI’s small and mid-sized clients during the global pandemic, BBSI’s share
price cratered well ahead of any real drop in revenue or profit forecast. And although much of the uncertainty of their
forecast has been removed, investors cannot be blamed for shying away from a
business so closely tied to businesses the size of BBSI’s clients. This lack of interest in the stock is further
explained by the outsized performance of momentum and technology mega-cap
companies that have attracted so much money, attention, and produced high
returns during the Covid-19 crisis.
Valuation Drivers and Estimates
Augmenting articles posted by others, this posting focuses
on the factors that make BBSI a safe, good idea for investors looking for the
possibility of excellent returns without sacrifice of the margin of safety. As with most value plays, however, no
immediate rise share price is expected or likely. A timeframe of 1-3 year will be necessary for
BBSI’s value to be realized in the stock price.
Despite its wild swings in price, BBSI’s current 10-year
revenue growth stands at 14%. Future
growth expectations are supported by recent investments in technology and an
expansion strategy under the leadership of recently appointed CEO Gary
Kramer. Improvement in the stock price
is not solely, or perhaps at all, dependent on this growth. A full recovery from the pandemic alone
should be enough to raise the price to the $80-90 range. A more detailed review of each of the three catalysts
should help to reinforce this idea.
The three catalysts to drive BBSI’s share price above the current
levels include 1.) Leadership changes driving investor confidence, 2.) growth
in revenue driven by the expansion of BBSI’s business into new markets, both
geographically and client type and 3.) P/E multiple expansion due to restored
business at client companies.
o
Leadership Change
The recent retirement of Michael Elich, former BBSI CEO, is the first major catalyst for change and driver
for the expectation of a rising stock price.
While growth under Elich cannot be discounted, other issues surrounding
his tenure were destructive to shareholder sentiment. The most concerning were workers' compensation
reserve and inaccurate journal entries by the former CFO that resulted in DOJ
and SEC investigations and charges/fines against James Miller, the former CFO,
and BBSI as a company. Miller was said
to have benefited substantially by selling stock options that rose in value under
the improvements afforded by the fraud that he orchestrated. While Elich was not charged, the fact that
the issues occurred on his watch is cause enough for concern even without a
formal accusation or indictment of wrongdoing.
I find it unlikely that such actions occurred completely without his
knowledge, if not direct involvement.
Additionally, claims by employees on review sites such as Indeed
and Glassdoor were less than complimentary of Elich. Such negative claims are often motivated by
personal vs. business concerns and require careful review. However, items focused on the use of company jet,
sponsorship of events and the unusually high number of disparaging comments aimed
directly at the CEO cannot be ignored; particularly when coupled with the fraud
convictions. Shareholders clearly
agreed with this concern as a jump in stock price accompanied the announcement
of the retirement and replacement with Gary Kramer.
Kramer was brought to BBSI from Chubb Limited as CFO to
remedy the situation with the reserve and accounting issues in 2016. And, while it is still early in his tenure as
CEO, Kramer has wasted little time in taking steps to make an imprint on the
company in a seemingly positive direction.
One such example is a personnel move made shortly after Kramer was
appointed. The elimination of the Chief
Strategy Officer position seemed to point to some needed housekeeping (and
SG&A reduction) as he took the reins.
Kramer’s approach in his first conference calls and investor the presentation has made a positive impression on me as straightforward and
focused on providing stability and growth to BBSI. Additionally, the recent appointment a legal
counsel to the management team should begin to provide a backstop for the
concerns that have kept investors at bay in the years following the accounting
issues.
o
Growth Plans
Recently, BBSI became eligible to do business in all 50
states. This action allows BBSI to move
away from its West and East bases and into markets that will provide for
future, non-organic growth.
Additionally, BBSI has recently completed an upgrade to
their service and data platform called MyBBSI.
This upgrade will reportedly allow expansion of BBSI into PEOs that are
more white-collar, professionally based versus the grey or blue-collar clients
that they have traditionally served. Expansion
opportunity from this avenue has not been quantified but reduces barriers to
entry into other market types.
Kramer has identified growth by acquisition as one of his
objectives. He has explained that a “fit’
with the BBSI’s culture and business model as the key aspects of possible
targets. No specific growth targets have
been made public, but sustaining revenue growth consistent with the recent past
(absent the Covid-19 pullback) should be achievable. The growing unrestricted cash reserve provides
ample room for a number of smaller acquisitions like the ones discussed by
management without the complete sacrifice of their balance sheet strength.
o
Multiple Expansion to Normalized Levels
For a company growing revenue and net income as BBSI has
done over the past 9 years, a multiple that is near their all-time low and far
below both the market and peers points to recovery once the issues of the
pandemic have cleared. Estimating when
that will happen with any level of accuracy is impossible. In the meantime, BBSI’s stock will likely
continue to linger or drift lower with its low TTM and forward P/E multiples. Investors assuming anything other than a
range-bound movement in the price of BBSI stock before significant pandemic
clearing has occurred are likely engaging in wishful thinking. Moreover, ensuring the P/E multiple does not
regress after an eventual recovery will depend on BBSI building longer-term
confidence with the market that some of their past issues are indeed in the
past. Any hint of accounting or other
company/leadership integrity will very likely return BBSI to low multiple
status and should be cause to consider exiting any position in the company.
o
Stock Valuation
To derive a current and future price
range for BBSI, we look to it’s current and projected earnings with and without
growth. Below, an expected value for
one, two, and three years into the future is then given based on these values. This approach may appear as imprecise; however,
the range is included to illustrate the downside protection that BBSI affords
under most market scenarios.
Revenue growth was assumed at a rather modest 9% for the
years of 2022 and 2023 for which no projections are available from analysts.
For EPS values, I use the full range of values used by the 4
analyst that now cover BBSI for the 2020 and 2021 fiscal years. Further, I assume that
some of the existing unrestricted cash on hand is used for acquisitions and a
low level of stock buybacks. In the
“Low” side, the acquisitions are assumed to sustain, but not improve
revenue. Only under the worst
conditions, below the “Low” estimates would these assumptions not hold. Net margins are assumed at historical levels
under similar revenue levels.
Risks and Drivers Away from Estimated Value
As with all equity posts, this section should be carefully
considered. These comments are intended
to provide a review of the factors which can be expected to cause the share
price to diverge to the extremes or beyond the estimates provided.
In the case of BBSI, the most significant risk to price
appreciation is any real or perceived threats to timely and accurate company financial
reporting or any other legal issues that might impact the company’s finances. This is particularly true of any adverse news
regarding workers' compensation reserves or risks. It is no coincidence that the first 4 risk
factors listed in the most recent 10K relate to workers' compensation. Even against growing revenues, profits, and
cash reserves, BBSI’s past issues have
hung over the company like a dark cloud.
Institutional and retail investors alike are fully aware of this past
and will undoubtedly evaluate any small issue as a sign the company has not
reformed.
Further Downside Risk
Future Failed Acquisition(s)
In conference calls and investor presentations, BBSI CEO
Gary Kramer has pointed to the possibility that an acquisition that would
provide entry into a market where BBSI does not currently do business could be
one of their growth strategies. The
failure to profitability execute a future transaction of this type could drive
the price lower, even if overall company profits are not negatively
impacted.
Competitive
Pricing Pressure
BBSI
operates in an ever-growing space of outsourced personnel services. Continuing to maintain a high retention rate
among their client base will depend on remaining competitive in that
space. As size and scale become a
factor in activities such as payroll processing, it is possible that
innovations by larger firms focused on these specific areas may make this
segment of BBSI’s business unprofitable or a drag on their model. It is not possible to quantify just how this
would impact BBSI, but currently, reported retention rates may not fully reflect the erosion of this type which might ultimately impact margins.
To the Upside
Higher Than Expected Growth
Either organic and/or inorganic growth that exceeds the
9-10% assumptions that are part of the valuation above will almost certainly
raise the stock price beyond provided estimates, all other things being equal. Despite its past troubles, BBSI has seems to
handle the scaling of their business model without issue. This model and recent information platform
upgrade should enable continued margin expansion as BBSI increases revenue
through increased client counts. BBSI
has expressed interest in entering the more employer-friendly markets of Texas
and Florida. If successful in these
markets, growth to the upside could be expected to far outpace projections.
Solid and Consistent Financials
BBSI’s recent sale of a portion of their workers
compensation liability reinforces the company’s position that their book of
claims and reserves are in line with risk profiles of those claims (see
press release here.) It is my view
that the key statement in the release that, “The transfer price of the LPT was approximately equal to the
book value of the claims liabilities with no material gain or loss on the
transaction.” This substantiates that
BBSI’s claims reserves are indeed appropriate and that WC claims are much less
likely to impact the company’s performance going forward. Should BBSI be able to stabilize their earnings
coming out of the pandemic and find drivers that would further reduce the
cyclicality of their business model, the market would almost certainly assign a
higher multiple to the stock.
Final Thoughts About BBSI
Clearly, the operating space of small and mid-sized businesses
that BBSI serves is counter to a major and growing US trend toward mega-cap company investing bias. This trend has prevailed since the
financial crisis of 2008 as a dominant investment theme. The underperformance of value and small-cap
stocks over that time has been the subject of countless articles and
discussions. If this trend continues, it will undoubtedly provide a headwind for
BBSI’s clients. Whether that trend
translates into a headwind for the company has yet to be seen and will certainly
not help their case.
By the same token, should that trend reverse course, BBSI’s
current value status and small company association will almost certainly be a
tailwind for the company.
At this time, investors should consider these macro drivers as tiebreakers, but not necessarily primary considerations for investment in BBSI. The potential for stabilizing the company, growing their solid business model, and reaping the benefits of returning investor confidence are the primary reasons for investing in BBSI. As the impacts of the global pandemic subside, BBSI should be well-positioned regardless of these and other macro trends.
