Urbem's 'Wonderful Business' Series: Exponent

A consulting niche player with a reputation moat

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Dec 10, 2019
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California-based Exponent (EXPO, Financial) is an international consulting firm that provides solutions for complex engineering and science problems for clients in a wide range of industries. What sets the company apart from most other consulting firms is its multidisciplinary team of scientists, engineers and business consultants across more than 90 different technical disciplines. 87% of the staff at Exponent has at least one postgraduate degree. As of 2018, the consumer products, transportation and energy/utilities industries respectively represented 27%, 16% and 15% of the company’s total sales.

The main reason that we find the business attractive is its consulting specialty in the niche of failure analysis. According to the most recent filing, 60% of the projects at Exponent are “reactive” in nature, covering litigation support, product recalls, regulatory actions, insurance investigations and so forth. In this regard, Exponent possesses an unparalleled track record of putting its name behind many well-known investigations, including Oso Landslide (the single deadliest landslide in U.S. history) in 2014, Superstorm Sandy in 2012, the PG&E Explosion in 2010, the safety issue related to Toyota Vehicles in 2010, the crash of American Airlines in 2001, the 9/11 attack in 2001 and the Kobe earthquake in 1995.

With abundant experiences throughout the past 50 years in the failure analysis niche, Exponent has established a reputation for reliability. As a result, the company may be able to win new businesses and even charge premium prices, as clients that are under crisis mode could be reluctant to hire an unproven firm to do a mission-critical project for them.

The sustainable competitive edge at Exponent also contributes to the high quality of revenue. The “reactive” portion of the business is relatively recession-proof and cash-rich. As you can see below, the company consistently generated more annual free cash flow than annual profits for more than a decade.

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Throughout the past three recessions, the overall business stood up well and even increased its sales and operating profits in some years (see below). The contained recession risk at Exponent is also attributable to the diversified client base, mixed with many non-cyclical domains like food, beverage, nutrition, life sciences and government.

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Compared to our selected group of peers, including IBM (IBM, Financial), Intertek (LSE:ITRK, Financial), and Navigant Consulting (NCI, Financial), Exponent delivered superior, stable and improving returns of capital (see below).

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Exponent has been expanding its businesses both domestically and internationally, opening overseas offices in Europe and APAC. The U.S. market accounted for roughly 88% of total revenue in fiscal 2018. In addition to new geographies, the company is also searching for opportunities to expand its services across industries and practices. We believe that the increasing complexity of technology would be a favorable long-term factor for an engineering and scientific consulting businesses like Exponent.

On the risk front, our biggest concern for the long run is any impairment to Exponent’s reputation, which would narrow the moat and make it difficult to rebuild. Additionally, the non-recurring nature of consulting revenues leads to less predictability of future cash flow. We also notice the insignificant insider ownership (1%-2% per Simply Wall Street and GuruFocus), given the scant $3.4 billion market cap of the company.

Disclosure: The mention of any stock in this article does not constitute an investment recommendation; investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market; we do not own any stock mentioned in the article.

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