Transcat (TRNS): A Quality Business At Only A Decent Price

When it comes to the sciences, accuracy is imperative. Being off even a tiny bit can have disastrous effects. Because of how important it is that accuracy is ensured, it should come as no surprise to investors that there would be entire companies dedicated to providing calibration services and other related services and products involving test, measurement, and control instrumentation. One such business that investors should be aware of is Transcat (NASDAQ:TRNS). In recent years, the company has done quite well to grow its top and bottom lines on a fairly consistent basis. It’s certainly not a fast-growing enterprise, but it is a healthy one. Unfortunately, though, shares of the business do look a bit pricey at this moment. Because of this, I can rate it no higher than a ‘hold’. But in the event that shares fall nicely from here and/or if we see a nice uptick in growth, this picture could change for the better.

Accuracy is everything

As I mentioned already, Transcat is dedicated to providing calibration services and performing other related activities when it comes to test, measurement, and control instrumentation. For the most part, the company focuses on providing its services and products to highly regulated industries such as the life sciences space. This includes pharmaceutical, biotechnology, medical device, and other related firms. But it should be made clear that the company’s emphasis is not only on the medical space. It also provides services for other heavily regulated industries like the aerospace and defense industrial manufacturing markets, energy and utilities, and more.

Operationally speaking, Transcat engages in activities through its two operating segments. The first of these is the Service segment, through which the business offers calibration, repair, inspection, analytical qualifications, preventative maintenance, consulting, and other related services. Most of these activities are processed through CalTrak, its proprietary asset management system, as well as through its online customer portal called C3. This segment currently operates no fewer than 24 calibration service centers spread throughout the US, Puerto Rico, and Canada. But it also conducts business through the facilities of its own clients when it comes to longer-term contracts, if and when needed. Some of this work may also be conducted through the use of mobile calibration laboratories that the company has in its portfolio. Based on data from the company’s 2022 fiscal year, this particular segment is responsible for 59.5% of the firm’s revenue and for an impressive 66.6% of its profits.

The other segment the company operates is called Distribution. This unit is responsible for selling and renting national and proprietary brand instruments to customers across the globe. Using its website, in-house sales team, and other activities and resources, the company is able to offer its customers over 150,000 tests, measurement, and control instruments. This includes offerings from over 500 leading brands. The company does not just limit itself to the selling of these products though in this segment. Given the highly sensitive nature of the technology it works with, it also calibrates them if needed at the point of sale and also at regular post-sale intervals. Other related services are also offered through this segment to customers who need them. Last year, this segment accounted for 40.5% of the company’s revenue and for 33.4% of its profits.

While Transcat may not be a rapidly growing business, it is a firm that is growing pretty consistently. Between its 2018 and 2022 fiscal years, the company saw its revenue rise year after year, climbing from $155.1 million to $205 million. The greatest increase in revenue for the business came from 2021 to 2022 when sales jumped 18.3% year over year. This rise was driven largely by a 20.5% surge in revenue associated with the company’s Service segment, with management attributing this trade combination of organic growth and acquisition-related growth. About $9 million worth of the sales increase under the Service segment came from various acquisitions, with the rest being attributed to organic means. Meanwhile, Distribution growth was a bit slower at 15.1%, but both organic growth and acquisition-related activity growth were positive for the firm.

This increase in revenue has usually been accompanied by improved profitability. In four of the past five years, profits rose year after year, with net income rising from $5.9 million in 2018 to an all-time high of $11.4 million in 2022. Other profitability metrics have been a bit more volatile. Operating cash flow has generally risen, climbing from $9.9 million to $17.6 million. But the high point was the $23.6 million reported in 2021. If we adjust for changes in working capital, however, we would see consistent year-after-year expansion, with the metric growing from $14.3 million to $24 million over the past five years. A virtually identical trend can be seen by looking at EBITDA. Over the past five years, this metric has grown from $16.4 million to $26.3 million on an adjusted basis.

At present, we also have data covering through the first half of the 2023 fiscal year. During this time, revenue totaled $111.1 million. That represents an increase of 13.1% over the $98.2 million reported the same time last year. Service revenue continues to be the fastest-growing portion of the enterprise, with revenue there jumping 21.1% compared to the 2.1% increase experienced by the Distribution segment. $6.9 million was the amount associated with additional acquisitions the company had made. The rest of the growth, meanwhile, was associated with organic activities. Although revenue rose nicely year over year, profit figures have been a bit mixed. A decrease in margins was instrumental in bringing net income down from $6.7 million in the first six months of 2022 to $5.4 million at the same time in 2023. Operating cash flow fared even worse, dropping from $7.5 million to $5.2 million. Fortunately though, if we adjust for changes in working capital, the metric would have risen from $12.5 million to $12.9 million, while EBITDA rose from $13.2 million to $14.8 million.

Management has not really offered any guidance when it comes to the current fiscal year other than to say that revenue under the Service segment should continue to rise nicely. If we simply annualized results experienced so far, we should anticipate net income of $9.2 million, adjusted operating cash flow of $24.8 million, and EBITDA of $29.5 million. Based on these numbers, the company would be trading at a forward price-to-earnings multiple of 57.5. The forward price to adjusted operating cash flow multiple would be 21.3, while the EV to EBITDA multiple would come in at 19.6. In the chart above, you can see how this pricing stacks up against pricing if we were to use data from 2022. In the table below, meanwhile, you can see how the company is priced against five similar firms. On a price-to-earnings basis, these companies ranged from a low of 2.1 to a high of 62.3. Using the price to operating cash flow approach, the range was from 2.6 to 32.8. In both of these cases, four of the five companies were cheaper than Transcat. Meanwhile, using the EV to EBITDA approach, the range was from 1.4 to 8.1. In this case, our prospect was the most expensive of the group.

Company	Price/Earnings	Price/Operating Cash Flow	EV/EBITDA
Transcat	46.4	22.0	22.0
DXP Enterprises (DXPE)	12.9	32.8	8.1
Hudson Technologies (HDSN)	4.5	8.1	3.5
BlueLinx Holdings (BXC)	2.1	2.6	1.4
Alta Equipment Group (ALTG)	62.3	9.4	7.3
Karat Packaging (KRT)	11.1	12.3	6.6

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Takeaway

Based on the data we have at our disposal, Transcat seems to me to be a healthy and growing company that should continue to do well for itself and its investors in the long run. The company looks to be a solid prospect for those who have a very long-term investment horizon. Having said that, shares of the enterprise do look to be rather pricey on both an absolute basis and relative to similar firms. Given the quality of the operation and the consistency of its steady growth, I cannot in good conscience rate the business a ‘sell’ despite the hefty price tag that shares come with. If the stock were to fall further, I could see myself becoming slightly bullish on the firm. But for now, a ‘hold’ rating seems most appropriate to reflect my view that shares should generate returns that more or less match with the broader market should achieve.