Calling In the Consultants

 | Aug 01, 2013 | 10:00 AM EDT
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Concentrated power is not rendered harmless by the good intentions of those who create it. --Milton Friedman

Like most investors, I have spent much of the last two weeks going through a multitude of second-quarter earnings reports. I have noticed that the small specialty consultant firms are doing quite well and are generally easily beating expectations. This continues a trend that has been strong over the last quarter or two.

This makes a lot of sense. Increasing government regulations and new policies such as the Affordable Care Act and Dodd-Frank Wall Street Reform and Consumer Protection Act have created myriad new compliance requirements, which are impacting numerous operational processes throughout different industries. Corporations are also still reluctant to hire new employees -- especially on the high end -- to deal with these new complexities. So they are reaching out to consultant shops to come in and analyze new regulations and policies and then recommend the necessary modifications to adjust properly to these changes.

For example, on Tuesday, Huron Consulting (HURN) reported that earnings doubled, year-over-year, driven by a 26% revenue increase in its healthcare consultancy group. Evidently, helping companies as well as healthcare facilities get ready for the upcoming Affordable Care Act is a very lucrative business right now. Given that these policy changes will take place over years -- and even more regulations are in the pipeline -- consultants should see a nice spike in demand for the foreseeable future. Here are two companies that appear to be well positioned to benefit from an increasingly stringent regulatory environment.

Navigant Consulting (NCI) is a small, Chicago-based consultancy firm that focuses on sectors that are facing transformational change and highly technical, complex regulatory and legal issues in the healthcare, energy and financial industries. The company reported results on Tuesday that easily beat expectations. This was the third straight quarter Navigant has easily beat the consensus on both the top and the bottom lines. Healthcare now represents one-quarter of NCI's revenues, which grew 30%, year-over-year, in the just completed quarter. Its Financial, Risk & Compliance practice has seen revenues grow by more than 60% since the end of 2010 and it now generates more than $160 million in annual sales.

Navigant has increased earnings at a better than 20% annual rate since the end of 2010, yet trading at less than 12x expected 2014's earnings per share (EPS), the stock is not expensive. It is using cash flow to reduce its debt levels and has seen its leverage ratio move from over 2.2 at the end of 2010 to just over 1 currently. The company is also retiring stock at a solid clip through an existing repurchase program.

FTI Consulting (FCN) operates as a business advisory firm enabling organizations to protect enterprise values in complex economic, legal, and regulatory, environments worldwide. The firm helps companies navigate various regulatory bodies, advises on mergers and acquisitions (M&A) and restructuring as well as litigation matters and processes. Approximately three quarters of its revenue comes from North America. The company has easily beaten estimates on the top and the bottom lines for each of the last two quarters and is due to report its second-quarter earnings results in the near future.

FTI Consulting has a solid balance sheet and more than $150 million left on a stock repurchase program that represents more than 10% of its market capitalization at current levels. Earnings are expected to grow in the low teens for both fiscal 2013 and fiscal 2014 with the stock priced at a little over 13x 2014's projected earnings. Revenues are expected to grow at around 5% annually over the next year and a half, but could tick up if M&A activity picks up. 

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