Enterprise Hiring Normalization And Construction Demand Will Drive Long Term Earnings Recovery

Catalysts

About Star Equity Holdings

Star Equity Holdings is a diversified holding company operating building solutions, business services, energy services and investment platforms.

What are the underlying business or industry changes driving this perspective?

• Continued normalization of enterprise hiring activity at large global companies, combined with growing adoption of tech enabled and AI driven recruitment solutions at Hudson Talent Solutions, may lift segment gross profit back toward prior mid cycle levels and expand EBITDA margins as digital offerings scale.
• Reaccelerating demand for commercial and institutional construction, together with a growing backlog and focused mix shift to higher margin projects in Building Solutions, supports sustained revenue growth and structurally stronger mid 20s gross margins that can translate into higher consolidated earnings.
• Ongoing growth in natural gas and geothermal drilling, and customer preference for nimble, specialized providers, may position Energy Services to gain share and improve asset utilization, which could boost segment revenue and lift adjusted EBITDA through better fixed cost absorption.
• Realization of at least $2 million in merger related cost synergies, alongside a larger diversified platform sharing corporate services, is expected to lower corporate overhead as a percentage of sales and enhance net margins and free cash flow over the next year.
• Disciplined capital allocation, including accretive bolt on acquisitions funded with reasonably priced preferred equity and opportunistic share repurchases, may compound cash flow per share and support higher earnings per share as integration benefits flow through the income statement.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Star Equity Holdings's revenue will grow by 27.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from -3.2% today to 0.9% in 3 years time.
• Analysts expect earnings to reach $2.7 million (and earnings per share of $0.79) by about December 2028, up from $-4.8 million today.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 25.9x on those 2028 earnings, up from -7.4x today. This future PE is greater than the current PE for the US Professional Services industry at 24.9x.
• Analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.32%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The long-term slowdown in enterprise hiring and the current no hiring, no firing environment at many Fortune 500 companies may persist longer than expected, limiting recovery in Hudson Talent Solutions and constraining revenue growth and operating leverage in the Business Services segment. This would pressure consolidated earnings.
• Building Solutions is benefiting from a rebound in commercial construction, but continued softness in residential markets, potential cuts to government backed workplace and low income housing programs, and weather related project delays could reduce backlog conversion and compress mid 20s gross margins. This would weaken segment EBITDA and overall net margins.
• The energy drilling cycle remains fragile, with lower oil rig counts across producing basins and reliance on a smaller scale footprint. A prolonged downturn in hydrocarbons or a slower than expected shift toward natural gas and geothermal activity could limit utilization, dampen Energy Services revenue, and reduce adjusted EBITDA.
• The company is still recording GAAP net losses and is relying on merger synergies and efficiency gains at the corporate level. If the targeted 2 million of cost synergies are delayed or not fully realized, corporate overhead may remain elevated as a percentage of sales, which would restrain the path to sustainable net income and free cash flow.
• The growth strategy depends on accretive bolt on acquisitions funded partly with preferred shares and on value realization from public investments such as Gyrodyne. If acquired businesses underperform, if preferred dividend obligations rise faster than acquired cash flows, or if real estate liquidation proceeds fall short of expectations, capital allocation could dilute shareholder value and constrain future earnings expansion.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of $13.0 for Star Equity Holdings based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be $307.3 million, earnings will come to $2.7 million, and it would be trading on a PE ratio of 25.9x, assuming you use a discount rate of 8.3%.
  
• Given the current share price of $10.29, the analyst price target of $13.0 is 20.8% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.