|Shares Out. (in M):||65||P/E||0||0|
|Market Cap (in $M):||48||P/FCF||0||0|
|Net Debt (in $M):||7||EBIT||0||0|
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Command Center is a $48M provider of temporary staffing services, operating within the short-term manual labour segment. The company currently operates 54 branches in 22 states, doing business primarily under its Command Center Brand.
Investment Thesis Summary
A Leaner Cost Structure and Improved Margins Drive Strong FCF profile
Prior to 2013, management put on heavy focus on growing the top-line as the company opened up 9 new branches and saw revenues grow by over 40% between 2010 and 2012. However, this was accompanied by an almost 50% rise in SG+A as well as significant working capital investments that depressed free cash flow. These results put pressure on founder Glenn Welstad, who resigned in early 2013.
In February 2013, the company brought in Frederick Sandford, a serial entrepreneur with a wealth of experience running and consulting to small businesses. Over the last 18 months, Sandford has put a focus on doing better margin business, putting up high single digit SSS growth and closing unprofitable branches. These efforts resulted in 240bps of gross margin expansion and a significant decline in the company’s SG+A spend to 17.2% of sales. Collectively, these improvements have caused adjusted EBITDA to grow from $2.8M in 2012 to $6.8M on a TTM basis and margins to expand from 2.9% to 7.2%. Alongside the significant jump in profitability, the company was able to realize working capital efficiencies through an improved cash conversion cycle. These improvements drive a 14.5% FCF yield on a TTM basis, an impressive result when you consider that the company hadn’t been FCF positive since 2010. I believe that the market is only beginning to realize these improvements and as a result, there is a very compelling risk/reward without the need for aggressive growth assumptions (See Valuation section for a complete discussion).
Impressive Unit Economics Give Credit to a Growth Story
In August the company reached something of an inflection point as it opened up its first net new branch since 2012. This implies that the company has begun to move from right-sizing its operations to a modest growth story. While, at first glance, mid-single digits top-line growth may not seem all that exciting, the capital-lite nature of the business model implies that the economics behind these branches are incredibly attractive. I estimate that every additional branch produces an IRR of roughly 24% implying the growth story has the potential to create a significant amount of value for shareholders. For anyone trying to recreate my numbers, I make the following assumptions:
If you can’t wrap your head around these numbers (or merely don’t like them), consider the industry context. We are increasingly seeing acquisition-based growth strategies from both strategic and financial buyers. As an example, we recently saw PE-Sponsored BG Staffing list on the NYSE-MKT as well as initiate investor relation functions in what I believe is an attempt to raise capital for their “Acquisition by Growth” strategy. Clearly, the growth imperative in this industry is significant so the real question comes down to execution. CCNI has a clean balance sheet, generates a ton of FCF and has been showing growth in pretty much every metric possible. Given you are not paying for the growth story (again, see valuation), CCNI is by far the best risk/reward in the industry.
Acquisitions Serve as Basis for Long-Term Growth Strategy
Temporary staffing is a $100B industry with some 100 national competitors and thousands of regional and local shops. Given the fragmented nature of the industry and the unit economics described above, both strategic and financial buyers have attempted to roll-up smaller shops in the hope of achieving scale and strategic position.
While unlikely in the short-term, management has commented that acquisitions will a part of their future growth strategy. I believe this opportunity could create significant value from several perspectives. To begin, there are several synergies in the model that, albeit, are hard to quantify, appear attractive. On the top-line, acquisitions give the acquirer access to customer lists, new market verticals, and the ability to cross-sell services across its customer base.
On the cost side, we can use TrueBlue (NYSE: TBI) as something of a case study. TBI has been accretively buying smaller players, closing a significant number of those branches, and attempting to build out a platform where all administrative functions are centralized to a main hub. While the company hasn’t disclosed a cost saving figure, it has repeatedly mentioned that the cash-on-cash returns from these acquisitions are in-excess of the company’s ROE, a figure already in the mid-teens.
Large Insider Buying
Over the past 6 months, we have seen extensive insider buying from Sandford as well as JD Smith, a member of the board. Collectively, they have purchased 276,000 shares on the open market at prices ranging from $0.45-$0.73 (Read: Today’s Price) with the most recent purchase coming only a few weeks ago on November 19th. I believe these transactions signal confidence in the business model and better align insiders with shareholders, both of which investors should view as huge positives to the thesis.
Looking Forward: Modest Top-line Growth, Stable Gross Margins, and a Disciplined SG+A Spend
Revenue growth in this industry is a function of billable hours and billing rates, both of which exhibit long-term, reasonably stable, growth trends. Using the bureau of labour’s statistics on the temporary staffing industry I believe we can expect to see a long-term CAGR of roughly 4% in billable hours and 1-2% in billing rates, suggesting a long-term organic growth environment of 5-6% annually. For those investors who prize revenue visibility, these figures are available monthly and can give you insight into industry trends well before a company ever reports earnings.
As we flow down the income statement, I have assumed no gross margin expansion as the company already puts up an impressive margin at 27%. Based on earnings calls, I believe that the industry benchmark belongs to TrueBlue’s legacy businesses which I estimate puts 28-29% margins. It should be noted that CCNI did see a 27.7% margin in its latest quarter, although Q3 does tend to be the company’s strongest.
Finally, I expect that we will see a modest decline in SG+A from ~19% of sales to 17% long-term, a figure the company has been able to hit in several quarters off of a larger revenue base. Using the industry for reference, this assumption is very conservative as most players run an SG+A spend between 13-15%. Of course, other participants also see much lower gross margins and I believe it is fair to assume there are inherent marketing investments that are required to maintain the pricing power CCNI is currently seeing. Running out these assumptions, I believe the company will do roughly $7.1M in EBITDA in 2014 and $7.5M in 2015 implying 7.6% and 7.9% margins respectively.
A Discounted Valuation that Doesn’t Match the Fundamentals
While the margins in this business aren’t amazing, the model is surprisingly capital efficient, which lends itself to strong FCF generation. Given that this is something of a turnaround story, I give estimates of both 2014 FCF and a more “normalized” view based on explicit investment requirements. In both situations, I estimate that you are not paying for the growth story, which I believe lends itself to a very favourable risk/reward.
2014 Free Cash Flow Estimate Implies 13% FCF Yield
I estimate that the company will do roughly $5.6M in operating cash flow based on continued working capital efficiencies that will result in a net negative spend of ~$600,000 for the year. To illustrate where this value comes from, note that the company has made significant working capital improvements since Sandford took over in 2013 in the form of improved receivables management. This has resulted in a 20% decrease in its cash conversion cycle since Q1 2013 (on a non-annualized basis). Factoring in an expected $300,000 in capex, I expect the business to do $5.3M in FCF for the year.
With a market cap of $48M, $6M Net cash position, and a $700,000 tax asset, the business is currently trading at a 13% FCF yield. To put that into perspective, a standard DCF (10% discount, 3% terminal) analysis implies that FCF would have to decline at nearly 5% a year to justify the current price.
Normalized Yield View Implies $1.20 target price
Of course, one could rightfully argue that working capital is a necessary investment in this business so a normalized view should include a moderate spend. While I expect improvements in 2014, as the growth story begins to emerge, the business should be investing roughly $750,000 in working capital a year, implying a normalized yield of 10%. If we assume absolutely no growth and thought about this as a perpetuity, the stock is flat, implying that you are paying for a mature going concern while receiving a growth story.
To be conservative I am going to use my 5% organic growth assumption as a proxy for free cash flow growth, leaving the branch count story as upside to the model. Using the same DCF assumptions described above, I believe the business is fairly valued at $1.20, about a 60% upside from today’s price.
The market is only beginning to give the company credit for a successful turnaround that has seen improved margins, a leaner SG+A spend, and significantly improved free cash flow generation. Moving forward, investors have a free option on an attractive growth story with a board who has made every effort to align their interests with shareholders. I believe the mispricing comes from a lack of awareness of the story and will disappear with continued execution.
i) Continued execution on turnaround story
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