HRnetgroup - RHB Invest 2017-11-02: Recruitment Leader Embarking On Acquisition Spree

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HRNETGROUP LIMITED CHZ.SI

HRnetgroup - Recruitment Leader Embarking On Acquisition Spree

• HRnetgroup is a premium recruitment firm and among the largest recruitment companies in Asia-Pacific ex Japan. It generates superior net margins compared to peers, with strong cash flows, low capex requirements, and a net cash position of SGD280m. 
• The stock trades at an effective 2018F ex-cash P/E of 11x vs the peer average of 16.7x. We believe it will likely embark on an acquisition spree from the start of 2018, which would boost NPAT growth on top of steady organic growth and decent dividend yields. 
• Initiate coverage with BUY and DCF-derived TP of SGD1.14 (33% upside).

Market leader with stable growth and superior margins. 

• HRnetgroup is a market leader in terms of recruitment, especially in Singapore. The group is also able to generate consistent, steady and high gross and net margins, which have remained steady at 36.4-39.6% and 11.7-13.3% respectively over the past few years – this is far better than listed peers in the region excluding JAC Recruitment (2124 JP, NR), which is highly commendable.

Investment Merits 

Deceptively high valuations but a gem upon closer look – 2018F ex-cash P/E of 11x.

• On paper, the stock is trading at 2018F P/E of 18x, which is high compared to the peer average of 16.7x. However, if we take a closer look, the company does not have any debt, and has amassed a huge cash pile of SGD280m after the IPO. 
• In addition, it has reduced minority interest through the 88GLOW plan after the IPO to 6.4% from 18+%, which will provide a big bump to PATMI.
• All in, the stock is actually trading at an effective ex-cash 2018F P/E of 11x, which is much lower than the peer average of 16.7x. If the group is able to utilise its cash position for accretive acquisitions, the P/E will likely be reduced even further in our view.

Strong insider buying from management. 

• Management has been buying shares from the market in six separate occasions despite the shares being listed only back in Jun 2017. It was only recently, on 29 Sep that management bought SGD0.26m worth of shares from the open market. With the purchases, they have increased their total stake in the company to 74.29%. This is in addition to no vendor shares being sold during the IPO, as well as the expiry of the lock-up period. 
• We believe this shows a strong vote of confidence by the management with regards to the outlook for HRnetgroup.

Ready for acquisition spree with net cash of SGD280m. 

• HRnetgroup has been growing organically since the company started operations, which is a formidable feat. However, management has expressed interest that they are keen to grow inorganically, through acquisitions, especially in other parts of the world, like Australia, China, and Europe. They will also likely be targeting recruitment firms, specialised in a specific sector, which will further add an edge and niche to the group’s existing profile.
• With a net cash hoard of SGD280m raised from its recent IPO, coupled with SGD15-20m free cash flow a year despite a dividend payout ratio of 50%, we believe that the company is well positioned to go on an acquisition spree to boost its growth rapidly in existing markets as well as new markets. With the substantial amount of cash available, we expect management to be aggressive on this front while also being prudent and safeguarding shareholders’ interest as management also owns 74% of the company.
• We think the acquisitions could potentially occur as early as 1Q18. We have structured different scenario analyses below showing the impact on the group’s bottomline, assuming an allocation of SGD200m for acquisitions and that these acquisitions would be accretive.

Strong cash flow generation and solid balance sheet. 

• The group has been generating significant positive cash flows from operations steadily, with minimal capex incurred due to the nature of its business and effective management. As a result, this adds on to our belief that the majority of cash raised through its IPO will likely be used for acquisitions.
• In addition, management has committed to a 50% dividend payout for 2017F-2018F, which is entirely possible given the solid cash flow generation, debt free balance sheet, and low capex requirements.

50% dividend payout policy for 2017F-2018F. 

• During the group’s IPO earlier this year, management had committed to a 50% NPAT payout as dividends for 2017F-2018F. This will result in a potential dividend yield of 2.6% for 2017F and 3.1% for 2018F. However, if the SGD280m cash pile were to be utilised for accretive acquisitions, we could see a potential uplift in yields in the coming years.
• In addition, with healthy cash flow generation and low capex requirements, we think that it is highly possible for the company to maintain their 50% NPAT payout beyond 2018F.

Better margins compared to peers. 

• The group is able to generate consistent, steady and high gross and net margins, which have remained steady at around 36.4-39.6% and 11.7-13.3% respectively over the past few years. This is mainly due to excellent cost controls and operational excellence of the management team, which owns the majority and controlling interest in the company.
• If we compare the group’s net margins against listed peers around the region, excluding JAC recruitment which does mainly professional recruitment and enjoys higher gross margins, HRnetgroup’s margins far exceed that of its competitors, which we believe is highly commendable. This solidifies its position as a premium recruitment firm, especially around the region in our view.

Stable organic growth from both revenue streams. 

• HRnetgroup has been growing both its revenue streams consistently and organically since it started operations in 1992, despite suffering a drop in business during the financial crisis. We expect the steady organic growth to continue as there is still room to expand in the cities where it operates.
• According to Frost & Sullivan, growth in the recruitment industry is expected to continue at a CAGR of 7.8% to SGD742.7bn by 2021 from SGD509.5bn in 2016, substantiating the possibility that the group’s historically stable organic growth trend would continue.

Premium and largest market player in Singapore. 

• According to an independent market research report by Frost & Sullivan, HRnetgroup is by far the largest recruitment agency in terms of number of listed consultants, revenue, as well as market share of 20.5% in 2015.
• Diversified recruitment across countries and sectors to spread risks and also provide more opportunities for growth. Currently, the group operates in 10 Asian growth cities, namely Singapore, Kuala Lumpur, Bangkok, Hong Kong, Taipei, Guangzhou, Shanghai, Beijing, Tokyo and Seoul.
• HRnetgroup intends to accelerate its growth and further strengthen its position by aggressively expanding its consultancy workforce with a particular emphasis on North Asia. It would also likely seek out new markets in Australia and Europe. The group’s revenue is well diversified across different sectors, which in turn helps to mitigate its risks in the event a specific sector does not perform well.

Valuation 

Initiating coverage with BUY and DCF-derived TP of SGD1.14 with WACC of 8.5%. 

• We initiate coverage on HRnetgroup with a DCF-derived TP of SGD1.14, and a Conviction BUY on the stock. Our assumptions are listed below: 
  1. Bloomberg WACC of 8.5%; 
  2. Terminal growth rate of 1.0%.
• HRnetgroup has a net cash position of SGD0.28 per share or SGD280m in total, which makes up over 30% of its existing market cap. We believe its management will likely utilise the cash pile for accretive acquisitions to boost NPAT. 
• Our DCF-derived TP suggests a 2018F ex-cash P/E of 16x, which is fair when compared to the peer average P/E of 16.7x.

Peer comparison 

Trading at a discount to peers. 

• HRnetgroup has consistently been generating stable net profits over the past few years, with commendable CAGR of 13.0% during 2014-2016. According to Frost & Sullivan, HRnetgroup is the largest Asia-based recruitment agency with the highest EBITDA margin of 16.3%, and net profit margin of 13.3% among key Asia-Pacific (excluding Japan) players in the industry.
• HRnetgroup is currently trading at a premium to industrial peers with Asia-Pacific presence, at 2017F P/E of 20x vs the peer average of 16.7x. 
• HRnetgroup however, has a significant net cash position of SGD280m or SGD0.28 per share, representing over 30% of its market cap. Stripping out its cash hoard, HRnetgroup is in fact trading at a discount to peers, at a 2017F ex-cash P/E of 13.5x.
• Looking at the group’s ROE of 21% as well as its prospective M&As, we expect its earnings to increase in the future, potentially leading to an even bigger discount to peers on a P/E basis.

Key Risks 

Fluctuations in general economic activity. 

• Demand for recruitment services could be affected by the general level of commercial activity and economic conditions in respective regions and sectors that HRnetgroup operates in. These economic downturns could be caused by a variety of reasons such as adverse political, socioeconomic changes and geopolitical issues. As such, HRnetgroup may see a decrease in demand for human resources as required by their clients, as the use of temporary employees might decrease or fewer permanent employees might be hired. 
• Business and profitability would also be affect if HRnetgroup is unable to attract new customers or existing customers do not renew their contracts.

Increased competition in the recruitment industry. 

• Human resource recruitment has relatively low barriers of entry for new entrants, as it does not involve a highly skilled workforce or a large sum of capital for fixed assets. It is also fairly easy for customers to switch to other competitors or even online recruitment platforms such as LinkedIn as the differentiation in services may be low. As such, the overall recruitment sector is highly competitive and fragmented in nature, and HRnetgroup might face price cutting pressure from both existing competitors and potential new entrants, which may be smaller and more efficient, and in turn affect HRnetgroup’s financial performance and financial condition in the future.

Large exposure to foreign exchange rate risk. 

• HRnetgroup has a large number of overseas subsidiaries and these firms provide profit and revenue in their respective local currencies. 
• As of now, HRnetgroup is exposed to SGD, HKD, JPY, MYR, CNY, KRW, THB and TWD. Since its revenue stream and costs are not naturally matched in the same currency, HRnet is exposed to any adverse fluctuations of foreign currencies against SGD, which could affect overall profitability of the group.

Increase in costs related to leases, insurance coverage, intellectual property, licensing, and lawsuit proceedings. 

• During HRnetgroup's course of business, there are many administrative costs that it incurs, such as leasing properties for their offices, providing insurance coverage for contractor employees and permanent staff, protection for trademark and intellectual property, government regulatory licences, or even lawsuit arising from disputes. These costs are generally recurring and foreseeable, but can increase unpredictably from time to time during the course of operations. 
• While these increments might be one-off, it may inevitably affect HRnetgroup’s profitability during that particular financial period.

Exposure to government regulations. 

• HRnetgroup is subjected to extensive government regulations in different countries of operation, and may be found to be in breach of certain conditions of these applicable licences or provision of law, regulation, codes of practice, standards of compliance or other regulatory requirements or guidelines, such as Labour Laws, Employment Acts, Tripartite Guideline on Fair Employment Practices, etc. In such events, the relevant government authorities may take action against HRnetgroup such as issuing warnings, demerit points, imposing penalties, suspending the licence, reducing the duration of the licence, or imposing additional conditions or restrictions on the licence, or even cancelling the licence. As a result, the business and profitability of HRnetgroup would be affected.

Financial 

Forecasts Revenue breakdown 

• About 75% of HRnetgroup’s total revenue comes from flexible staffing segment, while the rest comes mainly from the professional recruitment sector. Other contributors of revenue include the provision of human resource (HR) training, and payroll services.
• Going forward, we do not expect this ratio to change that much as the core operations of the group are ultimately providing professional recruitment and flexible staffing services. However, HRnetgroup has raised the temporary and contract staff headcount by more than 70%, to 347 people in 1H17 from 201 people in 2016. As such, we expect to see a stronger increase in revenue from the flexible staffing segment in 2017.

Margins

• On the other hand, professional recruitment contributes 66% of total gross profit, even though it makes up less than 25% of HRnetgroup’s total revenue. This is because there is no direct cost associated with professional recruitment services, thus gross profit margin is near 100%, while flexible staffing has sub-contractor expenses such as payroll and employee benefits that are borne by the group.
• Going forward, we do not expect this proportion to change that much unless HRnetgroup is able to reduce cost significantly through machines and automation or better cost management.

Net cash and capex 

• Healthy cash flows from operations coupled with low capex. Being asset-light and debt free, HRnetgroup has consistently been able to deliver steady cash flows from its operations to cover its minuscule capex needs.
• With a strong net cash balance of SGD280m, we believe HRnetgroup is in a solid financial position to expand and engage in M&A growth, thus generating more value to its shareholders. From 2014-2016, the group generated steady cash flows well above SGD40m pa from its operations.
• Going forward, we expect operating cash flows to improve as the demand for flexible staffing increases across Asia. Capex is expected to remain low at SGD1.0m for simple maintenance of furniture, office equipment and computers.

Company Background 

• HRnetgroup started off as a 4-person team founded by Chairman Peter Sim, who set up HRnet One in Singapore in 1992, focusing on two main businesses in professional recruitment and flexible staffing.
• Today, HRnetgroup is the largest Asia-based recruitment agency in Asia Pacific (excluding Japan), as compared to other key players with presence in Asia Pacific. The group operates 11 brands in 10 Asian growth cities, namely, Singapore (where the headquarters are located), Kuala Lumpur, Bangkok, Hong Kong, Taipei, Guangzhou, Shanghai, Beijing, Tokyo and Seoul.
• HRnetgroup’s professional recruitment and flexible staffing services serve close to 30 diversified sectors, covering a wide spectrum of industries such as including financial institutions, retail and consumer, information technology and telecommunications, manufacturing, healthcare life science, insurance and logistics, as well as functions such as human resources, finance and accounting, and legal and compliance.
• The group also offers other services, such as payroll processing, HR consulting and corporate training. HRnetgroup has over 2,000 clients, including 104 Fortune 500 clients such as Samsung Asia, Master Kong, Bundwealth, Seibu Holdings, Olympus, Fubon Bank, Gardens by the Bay, and Acer.

Brands under HRnetgroup

Brand	Positioning	Location
HRnet One	Flagship brand with more than 24 years in organisation building. Process and methodology driven, HRnet One leverages strongly on relationship and trust in providing solutions in talent acquisition, talent retention to talent management and development.	Singapore, Kuala Lumpur, Bangkok, Hong Kong, Taipei, Guangzhou, Shanghai, Beijing, Seoul and Tokyo
Recruit Express	More than 20 years in the business of managing a large candidate base of all levels of seniority for permanent, contract and temporary roles.	Singapore, Kuala Lumpur, Hong Kong and Taipei
PeopleSearch PeopleFirst	More than 16 years in success-based search for middle to senior level positions. Candidate-centric approach and sharpness in ascertaining clientÕs strategic intent results for speedy delivery.	Singapore, Kuala Lumpur, Hong Kong, Taipei, Shanghai and Tokyo
SearchAsia	Close to 10 years in offering premium and tailored recruitment services. Client-centric consulting approach to ensure the best job matches within a diversified spectrum of industries. In 2016, ranked 25 out of the 50 Fastest Growing Companies in Singapore based on outstanding growth in CAGR by DP Information Group.	Singapore and Hong Kong
RecruitFirst	Launched in 2013, the brand operates flexible staffing and professional recruitment businesses, adopting a vibrant mode of operations using the rhythm of activities, performance metrics and best practices distilled from various Group brands over the last 24 years	Singapore and Hong Kong
HRnet Performance Consulting	More than 16 years in providing consultancy services and training through innovative programmes to organisations to optimise their performance so that they are empowered to deliver results	Singapore and Kuala Lumpur
Recruit Legal	More than 11 years in placing candidates at leading international banks, financial institutions, Fortune 500 multinational companies, and global law firms	Singapore and Hong Kong
YesPay	Provides HR and payroll solutions using a proprietary self-developed technological platform that provides a unified web-based service, delivering electronic pay-slips and other e-services to clients various types and industries across Asia	Singapore
Young Talent	Launched in 2015 to create a flexible staffing platform with an aim for millennials to launch and grow their careers	Taipei

Experienced board of directors and management team. 

• The group’s management consists of an experienced team with many years in the human resource industry. The founding chairman, Mr Peter Sim, has close to 40 years of experience in HR functions and the recruitment industry. With his team of dedicated and competent directors, each having several decades of human resource industry exposure, HRnetgroup is able provide high quality recruitment services for all of its corporate clients. 

Professional recruitment division 

• Professional recruitment business involves strong collaboration with corporate customers to understand their business goals and ultimately fulfil their unique need for talent. 
• HRnetgroup has a strong pipeline of professional recruitment consultants with in-depth knowledge of various industry and functional specialisation, strong sense of business acumen and insight into the talent landscape in order to be able to successfully navigate the supply and demand of talent within their areas of specialisation. The nature of the business allows HRnetgroup to forge long-term relationships and create lasting value for its corporate clients.

Flexible staffing division 

• HRnetgroup also provides flexible staffing solutions for corporate clients who seek variability in operating costs and talent deployment, especially those who increasingly focus on core competencies while outsourcing non-core and back-office functions. This area of business has grown over the years due to the evolving global economy creating demand for flexible staffing as well as trend towards candidates seeking work-life balance, or students and graduates seeking work experience between school terms.
• HRnetgroup consultants work in teams and each team specialises in a particular industry in various geographical areas. Through multiple sourcing channels including their internal candidate databases, subscriptions to job portals, social medias and other digital channels, consultants are able to identify and review the suitability of candidates.

Jarick Seet RHB Invest | http://www.rhbinvest.com.sg/ 2017-11-02

RHB Invest SGX Stock Analyst Report BUY Initiate BUY 1.14 Same 1.14