Resources Connection Is No Longer An Attractive Investment (Rating Downgrade)

seekingalpha10-13

RGP's stock has declined 27% in TSR, with declining NOPAT and revenues, making it no longer a safe dividend source.1Q 2025 filings show worsening profitability, with a $5.7 million loss and declining ...

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SlavkoSereda/iStock via Getty Images Since writing about management consultancy firm, RGP (NASDAQ:RGP), on July 25, 2024, the stock has declined 27% in terms of total shareholder returns (TSR), compared to 7.5% for the SPDR S&P 500 ETF Trust (SPY). On October 4, the firm filed its first quarterly report for fiscal 2025. In that first article, I argued that regardless of the challenges to RGP’s profitability, with net operating profit after tax (NOPAT) falling from $33.7 million in fiscal 2020 (FYE May 25, 2025) to $23 million in fiscal 2024; and revenues which seem to have peaked in fiscal 2022 at $805 million and fallen to $633 million in fiscal 2024, RGP was a “safe source of dividends and its free cash flows (FCF) are trading at attractive levels. RGP is a lesson that a firm does not need to be great to be worth investing in because it is trading at a discount to its intrinsic value, and that offers investors an opportunity.” The 1Q 2025 filings have led me to change my stance: the firm remains attractively valued and now trades at a slight premium to its intrinsic value, but, support for dividends is weakening thanks to a decline in free cash flows (FCF) and FCF yields have fallen, and the challenges in the business model mean that continued declines in intrinsic value and stock price are to be expected. I am no longer recommending RGP.   Source: Morningstar Operating Profitability Continues to Decline The 1Q 2025 filing shows all the problems that RGP has suffered for so long: revenue for the quarter was $136.9 million in 1Q 2025b compared to $170.17 million in 1Q 2024. The company suffered a $5.7 million loss for the quarter compared to a profit of $3.12 million in 1Q 2024. However, GAAP net income, is, as always, flawed, and reversing the impact of non-core and non-operating items shows that the firm’s true profitability for the quarter and for the trailing twelve months (TTM). For instance, in the 1Q 2025 filing, there is a $3.9 million charge for goodwill impairment, and off the income statement, there is a $3.4 million gain on the sale of assets. Below, you will see my calculation for the firm’s NOPAT for the TTM period and the five years prior.            Values in millions 2020 2021 2022 2023 2024 TTM   GAAP Net Income $ 28.29 $ 25.23 $ 67.17 $ 54.36 $ 21.03 $ 12.21   Total Hidden Non-Operating Expense, Net $ 3.92 $ 11.86 $ 0.52 $ (0.67) $ 1.66 $ (3.39)   Reported Non-Operating Expense, Net $ 1.42 $ 0.27 $ 0.47 $ 3.13 $ (1.05) $ 2.95   Total Derived Data for the Net Income to NOPAT Reconciliation $ 0.03 $ (10.82) $ 11.17 $ 9.80 $ 1.50 $ 1.84   Change in Total Reserves $ - $ - $ - $ - $ - $ -   Goodwill Amortisation Expense, Net $ - $ - $ - $ - $ - $ -   Employee Stock Options (ESO) Expense $ - $ - $ - $ - $ - $ -   Interest for PV of Capitalised Operating, and Variable Leases $ 1.64 $ 1.66 $ 0.93 $ 0.93 $ 0.71 $ 1.03   Classification Disclosure Adjustment $ - $ - $ - $ - $ - $ -   Non-Operating Tax Adjustment $ (1.61) $ (12.48) $ 10.23 $ 8.87 $ 0.79 $ 0.81   Reported After-Tax Non-Operating Expense/(Income), Net $ - $ - $ - $ - $ - $ -   Reported Minority Interest Expense, Net $ - $ - $ - $ - $ - $ -   Reported Loss/(Gain) from Discontinued Operations After-Tax, Net $ - $ - $ - $ - $ - $ -   Reported Preferred Dividends, Net $ - $ - $ - $ - $ - $ -   Reported Dividends on Redeemable Preferred Stock, Net $ - $ - $ - $ - $ - $ -   Reported Other After-Tax Charges, Net $ - $ - $ - $ - $ - $ -   Net Operating Profit After Tax (NOPAT) $ 33.66 $ 26.54 $ 79.33 $ 66.62 $ 23.14 $ 13.60   Click to enlarge Sources: Company filings and author calculations As the reader can see, NOPAT, at $13.6 million, is superior to the firm’s GAAP net income, however, this is lower than NOPAT in fiscal 2024, which was $23 million. Support for FCF is Weakening The quality of dividends is determined by a firm’s long-term FCF generation. You want a business to earn more in FCF than it issues in dividends, because this gives support for future dividend issuance and possibly even growth in dividends. Since 2020, RGP has generated nearly $220 million in FCF, equivalent to 79% of RGP’s market cap, while issuing $96.7 million in dividends. However, in the 2024 and TTM period, dividend issuance has outstripped FCF generation, and the 2022-2023 period of FCF generation increasingly looks anomalous. In 2020, 2024 and the TTM, the difference between FCF and dividends is not so big, as the chart below shows. If this continues, then the quality of dividend issuance will be called into question. 2Q 2024 will reveal more. In addition, the attractiveness of the FCFs have declined given that they now have a yield of 2% compared to 4.9% in fiscal 2024.   Sources: Company filings and author calculations RGP is Attractively Priced As I said in my previous piece, a challenged business is not necessarily a bad investment. This remains true. The firm’s intrinsic value, as measured by economic book value (EBV) per share, which I have discussed in previous posts such as on Mueller Industries (MLI), has collapsed since fiscal 2023, from $32.61 to $7.82. Nevertheless, the firm has gone from being undervalued to fairly valued, with a price-to-EBV per share of 1.07. This implies that the firm will only ever increase NOPAT by 7% from current levels. Given the firm’s challenges, I think this is a reasonable assumption.            Value in millions, except per share amounts 2020 2021 2022 2023 2024 LTM   NOPAT $ 33.66 $ 26.54 $ 79.33 $ 66.62 $ 23.14 $ 13.60   WACC 5.25% 6.59% 7.29% 6.41% 6.43% 6.04%   Excess Cash $ 60.46 $ 42.92 $ 63.97 $ 78.00 $ 77.25 $ 59.65   Net Assets from Discontinued Operations $ - $ - $ - $ - $ - $ -   Net Deferred Tax Liability $ - $ - $ - $ - $ - $ -   Net Deferred Compensation Assets $ - $ - $ - $ - $ - $ -   Fair Value of Unconsolidated Subsidiary Assets (non-op) $ - $ - $ - $ - $ 8.91 $ -   Fair Value of Total Debt $ 124.92 $ 80.38 $ 74.96 $ 20.81 $ 15.96 $ 23.07   Fair Value of Preferred Capital $ - $ - $ - $ - $ - $ -   Fair Value of Minority Interests $ - $ - $ - $ - $ - $ -   Value of Outstanding ESO After-Tax $ 5.48 $ 2.47 $ 12.23 $ 4.75 $ - $ -   Pensions Net Funded Status $ - $ - $ - $ - $ - $ -   Economic Book Value (EBV) $ 571.21 $ 362.86 $ 1,064.94 $ 1,091.76 $ 430.09 $ 261.79   Split Adjusted Shares Outstanding (thousands) 32,144.00 32,885.00 33,197.00 33,475.00 33,556.00 $ 33,472.00   EBV per Share $ 17.77 $ 11.03 $ 32.08 $ 32.61 $ 12.82 $ 7.82   Stock Price (closing) $ 10.99 $ 14.58 $ 18.18 $ 15.57 $ 11.45 $ 8.35   Price to Economic Book Value per Share (PEBV) 0.62 1.32 0.57 0.48 0.89 1.07   Click to enlarge Sources: Company filings and author calculations Now, a PEBV of 1.07 is attractive, however, the continued deterioration of the business makes it likely that both the stock price and the economic book value of the firm will fall, destroying shareholder value. The decay in dividend quality is worrying, and the decline in the firm’s FCF and FCF yield mean that not only is dividend issuance less supported, but the attractiveness of the firm’s FCF has declined. Consequently, I am no longer recommending RGP. Conclusion  The 1Q 2025 filing shows that RGP’s problems, outlined in my first article, have deepened. Problems in a business happen, but what has changed is that the central thesis for investing in RGP was that the firm was a safe source of dividends, it was attractively valued, and that its FCF were trading at an attractive yield. These things are no longer true, and the continued problems RGP has suffered, mean that not only are you not getting the safe source of dividends, you are now holding a business whose intrinsic value and stock price are both more likely to fall than rise. That’s a bad investment.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2475811897"}