Today, I'd like to focus on a small-cap dividend stock that's come under pressure – and, as a result, one that investors may want to put on their radar screen.
The company
Morneau Shepell Inc. is a leading human-resources services provider offering employee assistance, health, benefits and retirement services. In terms of geographic revenue breakdown, approximately 90 per cent of revenue was from Canada, with the balance from the United States.
The company's positive attributes are outlined below.
Strong historical revenue growth: The company has been slowly but steadily increasing revenue. In 2012, revenue grew 15 per cent to $419-million from $365-million. In 2013, revenue climbed 12 per cent to $471-million, and last year revenue broke above the half-a-billion level to $536-million.
High recurring revenue: Recurring revenue has been in the high 90-per-cent range. For the past four years, recurring revenue has represented 98 per cent of total revenue, providing the company with stable, predictable cash flow.
Strong and stable customer base: Morneau Shepell serves more than 20,000 clients from small businesses to major organizations such as Suncor Energy Inc., Toronto-Dominion Bank and Johnson & Johnson. Many of the contracts span over several years. Approximately two-thirds of the companies listed in the Canadian large-cap benchmark, the S&P/TSX 60 index, are clients of Morneau Shepell. Looking at the top 25 clients, the average relationship has existed for approximately 13 years.
Solid management ownership: Of the 48 million common shares outstanding, management ownership represents approximately 10 per cent – a positive sign as management has a vested interest in the company.
Financial flexibility for small acquisitions: Last quarter, the company's debt-to-earnings before interest, taxes, depreciation and amortization (EBITDA) was 2.6 times, below the company's debt covenants and giving the company room to make small, tuck-in acquisitions.
Outsourcing trend: More companies are focusing on their core operations and outsourcing human-resource functions.
So, given these strong characteristics, why the weakness in the stock price? Decelerating growth is the main culprit.
Weaker-than-expected financial results: In the previous quarter, the company reported revenue of $142-million, up 1 per cent year-over-year and below the consensus estimate of $150-million. Organic revenue growth was 4.7 per cent, below the company's full-year organic-growth target range of between 6 per cent and 8 per cent. On the positive side, adjusted EBITDA was $28-million, up 3 per cent year-over-year, with margins expanding to 19.7 per cent compared to 19.3 per cent last year.
Management indicated on the second-quarter conference call that there are a number of large deals that could be announced in the near term, which could lift the company's growth into its targeted range.
Dividend policy
The company pays shareholders a monthly dividend of 6.5 cents a share, equating to 78 cents a year, or an annual yield of 5 per cent. The dividend has been maintained at this level since 2011, and appears sustainable. Last quarter, the payout ratio was 70.6 per cent of normalized free cash flow for the most recent 12-month period.
Valuation
The stock is trading at an enterprise value to EBITDA multiple of 9.2 times the 2016 consensus estimate, below its three-year average of 9.7 times and five-year average of 9.4 times. The stock is trading in the middle of its five-year EV/EBITDA multiple range of between eight times to 10.5 times.
Chart watch
The solid uptrend since late 2011 has been broken. Year-to-date, the stock price is down approximately 11 per cent. Technically, the stock price has been trading below its 50-day and 200-day moving averages – negative indicators.
For the past two months, the stock price has attempted to stabilize in the $15 to $16 range. There is downside support at $15, and failing that, at $14.70 and $14. There is upside resistance at $16 and $16.70, near the stock's 200-day moving average.
Analysts' recommendations
According to Bloomberg, since the beginning of August there have been five analyst reports on Morneau, with two buy recommendations and three holds. One-year price targets range from $17.50 to $19, with the average one-year price target at $18.60. The consensus revenue estimate is $565-million in 2015, rising 9 per cent to $617-million in 2016.
The bottom line
The stock's multiple has contracted, and rightfully so given the company's moderating growth. The company will be reporting third-quarter results on Nov. 9. I would wait for the financial results before taking any action.
As always, I strongly encourage readers to consult a financial adviser and to do their own proper due diligence before taking any investment action.
Jennifer Dowty, CFA, Globe Investor's in-house equities analyst, writes exclusively for our subscribers at Inside the Market. E-mail any stock suggestions that you want profiled to jdowty@globeandmail.com.