DLH Holdings Corp. (NASDAQ:DLHC) is in the business of providing healthcare services military personnel and veterans.
DLH’s services help veterans in some way from the beginning of their military life to the end. This includes setting up military treatment facilities, providing nurses in the hospitals, training the medic, all the way through to providing pharmacists, pharm techs and people who ship out prescriptions to veterans.
100% of DLH’s revenue comes from federal agencies including the Department of Veteran Affairs, the Department of Health and Human Services, and the Department of Defense.
Their revenue streams with these federal agencies as their direct clients are comprised of (as of March 31, 2018):
1. Health solutions for military personnel and veterans – 63% of revenue
2. Human services and solutions – 33% of revenue
3. Public health and life sciences – 4% of revenue
So, this is quite confusing because their core capabilities on their website encompass a lot more than the 3 above. It’s explained in their quarterly report that they are technology-enabled health solution provider by outsourcing the business process. It looks like their core capabilities include the capabilities of their outsourcing.
The obvious question is whether reliance on government agencies is a safe bet for the company in the long-term. Firstly, the have to bid and win contracts and although this gives them visibility into their revenue projection 1-2 years in advance, by the same token, they have to sustain the company with their own capital during that time until the project comes online. It’s crucial to maintain overlap so that they don’t have dip in revenue in any given year.
Secondly, the process of winning contracts means it’s not guaranteed and therefore you can’t really say that their revenue is recurring. I love recurring revenue model, so this concerns me. So one of the analysis questions is around the security of their revenue, which I added to my analysis questions below.
Zachary Parker has been CEO and director since 2010, which is not a long time given the company has been around for more than 2 decades. He has held leadership roles in company divisions dealing directly with the government such as GE Government Services (now Lockheed Martin). He is active in the defense and veterans government associations. I imagine having a strong relationship with the government is critical since 100% of their revenue comes from the government.
The rest of the senior management is a roster of strong background in government programs. Having worked closely in my day job investing in a company that gets the majority of the revenue from federal agencies, the most significant difference I found in government facing companies is that they have to be “cautious” in maintaining their relationship with their customers. They can’t be too aggressive and they have to follow the rules but they also can’t be completely nonchalant and expect the customers to come to them. So their management team seems to be stacked well to face the federal agencies as customers.
The company’s recent acquisition of Danya International whose capabilities are in the “human services and solutions” coupled with the composition of their management team’s experience suggest that their long-term vision is to solely focus on selling to government agencies.
The company has strong corporate governance with a proper audit committee, management compensation committee and governance committee.
The company’s had a successful growth in its revenue and EBITDA over the past 3 years although the jump in growth in 2017 is attributed to the newly acquired Danya International.
The good news is that the company has a positive cash flow and their interest cost is more than covered by its cash flow. The company has been deleveraging, paying off the debt each year. And with enough cash in the bank as at March 31, 2018 and a revolving credit line of $10 million, they would be able to pay the interest if they had a cash flow shortfall in a given year; i.e. they wouldn’t go belly up if they had a negative cash flow year in an odd year (if they consistently produced negative cash flows, then that would be a different story). Compared to their peers, their debt to equity ratio is slightly below the industry average. The debt is also at a reasonably low interest rate.
The bad news is that compared to its peers (although the peers are much larger), DLH’s margins are lower than the industry average. DLH’s operating cost as a % of gross profit (not as revenue since gross margin for each consulting business in the industry varies) is much higher than the industry average.
All in all, the company’s financial health is in an okay shape. They have positive cash flow, they are deleveraging and have enough access to liquidity to pay off their debt over the next 3 years. But their margins are lower than the industry average. Notably, an EBITDA margin of 5.2% for the most recent 6 months they reported is very low. The 3 year average EBITDA margin has been 4.9% so the profitability of the business is inherently very skinny.
Until the acquisition of Danya in May 2016, DLH’s organic financial statements didn’t look all that great. In 2013 and 2014, the company’s EBITDA were below a million dollars each year with 0.5% and 1.3% EBITDA margin, respectively. In 2015, they increased their revenue and improved their margins significantly and increased EBITDA and EBITDA margin to $3.2 million and 4.9%. I understand now why they needed the acquisition of Danya. This leads me to 2 interpretations:
Hmm, I don’t know about this company anymore.
A discounted cash flow model in this case is not the best to use because of the non-recurring nature of the revenues and because as an illiquid microcap company, the stock isn’t going to hold much weight in reflecting the intrinsic valuation.
So in this case, I used multiples to compare to DLH’s competitors. The competitors were found in DLH’s annual report. They are all much larger than DLH.
Compared to the industry average multiples in the table above, DLH’s share price now at $5.45 is undervalued. The company is better positioned in terms of leverage with a lower debt-to-equity ratio, which would actually be lower had DLH not acquired Danya International in May 2016.
But most of DLH’s competitors have established themselves as large-cap companies and pay a dividend. After the acquisition of Danya International in May 2016, the company’s stock rallied up for a little over a year until October 2017. Then the share price started declining gradually, which I have to think is attributed to the results of the acquisition after a year highlighted in the annual report.
Overall, the share price is undervalued compared to the peers but you have to discount the company’s valuation anyway because of its illiquidity, so I would say it’s fairly valued with that perspective.
According to this chart by Statista, the number of veterans in the US is projected to grow albeit small growth.
The main things to note are that the share price is slightly undervalued but if you take into account the discount for DLH being an illiquid microcap company, then it’s relatively fairly valued.
DLH’s financials looks okay as they have a positive cash flow, they have cash in the bank and they’re deleveraging after having taken out debt to acquire Danya International in May 2016. But since the acquisition, their operating cost has gone up quite a bit relatively speaking, so they need to contain their spending after figuring out the synergies.
They have enough access to liquidity if they have an odd shortfall cashflow year and although they have a high accounts receivable, the good thing is that the counterparty is the government so they have not had bad debts from ageing accounts receivable. But by the same token, the government is the only customer and more than 60% of their revenue comes from 2 departments of the government so there is major concern for customer concentration risk.
The leadership team is very experienced in dealing with the government as clients. But the CEO only owns 1% of the shares of the company and two of their directors have been selling their shares over the last year.
All in all, I picked this company to analyze because I saw potential. But after a rigorous investment analysis and following my investment checklist, I believe there is a cap on growth for the time being until they figure out how they can scale and there are too many risks that outweigh the potentials, so I’d rather not bet on this company.
I know, I’m bummed too. Days of analysis just to get to the conclusion to NOT invest my money in DLH. Well, at least you know I’m real and I don’t get paid by these companies to promote.
Thanks for reading and see you in the next one!