The past six months have been a windfall for Target Hospitality’s shareholders. The company’s stock price has jumped 152%, setting a new 52-week high of $20.42 per share. This was partly thanks to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
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Why Do We Think Target Hospitality Will Underperform?
We’re happy investors have made money, but we’re cautious about Target Hospitality. Here are three reasons why there are better opportunities than TH, plus one stock we’d rather own.
1. Decline in Utilized Beds Points to Weak Demand
Revenue growth can be broken down into changes in price and volume (for companies like Target Hospitality, our preferred volume metric is utilized beds). While both are important, the latter is the most critical to analyze because prices have a ceiling.
Target Hospitality’s utilized beds came in at 9,468 in the latest quarter, and over the last two years, averaged 29.8% year-on-year declines. This performance was underwhelming and implies there may be increasing competition or market saturation. It also suggests Target Hospitality might have to lower prices or invest in product improvements to grow, factors that can hinder near-term profitability. 
2. Mediocre Free Cash Flow Margin Limits Reinvestment Potential
Free cash flow isn’t a prominently featured metric in company financials and earnings releases, but we think it’s telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
Target Hospitality has shown poor cash profitability relative to peers over the last two years, giving the company fewer opportunities to return capital to shareholders. Its free cash flow margin averaged 9%, below what we’d expect for a consumer discretionary business.
3. New Investments Fail to Bear Fruit as ROIC Declines
We like to invest in businesses with high returns, but the trend in a company’s ROIC can also be an early indicator of future business quality.
Over the last few years, Target Hospitality’s ROIC has unfortunately decreased significantly. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
Final Judgment
We see the value of companies helping consumers, but in the case of Target Hospitality, we’re out. After the recent rally, the stock trades at 1,433.5× forward P/E (or $20.42 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - we think there are better opportunities elsewhere. Let us point you toward a top digital advertising platform riding the creator economy.
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