With a market cap of just $160 million, Providence Service (PRSC) is one of the smallest companies currently on the magic formula screen. As a matter of fact, if it was any smaller it’d be a serious contender for Gurufocus’ own Micro-Cap Magic Formula Newsletter. So what do they do? They operate two divisions. First, their social services business provides home-based counseling (think therapy for anger management) as well as foster care. Second, their NET Services division offers non-emergency transportation management, focusing mainly on state Medicaid systems. Federal law requires Medicaid to pay for transportation for anyone who can’t afford/provide their own, and this division will arrange all of the transportation for patients who need this service.
Both divisions are dependent on some form of government budgets, be it states, municipalities or Medicaid. The outlook for those three budgets isn’t exactly bright, and that outlook, plus some substantial leverage, has caused Wall Street to hammer the stock.
End of story, right?
Not even close.
PRSC’s services save states oodles of money. For example, in psychiatric care, PRSC’s services let states provide therapy to six patients for the same cost as treating one person in a psychiatric hospital. Six for one… it’s no wonder the feds are pushing more states to adopt this service.
In transportation, states can cut their transportation costs by 50% by outsourcing. Most states currently operate their transportation system through a taxi voucher system. Not only is this expensive, but it creates a black market for taxi vouchers and states can’t tell if people use them for hospital trips or to go to a casino. PRSC eliminates that. So states can cut costs in half and reduce fraud and waste? No wonder 30 states have already switched to outsourced transportation, with more on the way.
So as states and municipalities look to save money any place they can, and the Feds look to reign in out of control healthcare costs, demand for PRSC’s services could actually increase dramatically!
Clearly, PRSC can save government tons of money. But how much money can they make in the process?
A pretty nice chunk, actually.
PRSC employs about $210 million in tangible assets. Over the past twelve months, they’ve generated over $51 million in operating income and, if you adjust for amortization expense (an expense that has no economic basis), they’ve generated over $59 million in operating income. Those figures put their pre-tax return on assets somewhere between 25% and 30%.
So what are you paying for a company that generates returns on assets better than 80% of the S&P 500?
At quarter end, PRSC had net debt of just over $112 million and a market cap just over $160 million for an EV of $273 million. With operating income of $51 million, you’d be paying just 5.4x EV/EBIT for PRSC. If you believe (like I do) that operating income is actually closer to $59 million, you’re paying just 4.6x EV/EBIT.
For an asset-light business that has a proven ability to grow organically in the high single digits at outstanding rates of return, that valuation really doesn’t make sense.
The CEO probably said it best during a recent analyst conference. “We do believe our stock’s undervalued. We believe that value will come to us…”
While the near term could be rocky, given the uncertainty around government spending and some additional uncertainty over near term earnings, the long term is bright, and investors who buy the stock at today’s prices will likely be well rewarded.