HRNetGroup Ltd - DBS Research 2018-01-03: Opportune Time To Hunt

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HRNETGROUP LIMITED CHZ.SI

HRNetGroup Ltd - Opportune Time To Hunt

• Initiating coverage with BUY, TP: S$0.96 for 21% upside potential.
• Largest recruitment firm in Asia Pacific ex-Japan; poised to ride on labour market recovery.
• Recent share price movements pose good entry point at attractive FY17F/18F ex-cash PE of c.13x/11x.
• High net cash at 35% of market cap supports inorganic overseas growth opportunities.

Initiate coverage with BUY, TP: S$0.96; trades at ex-cash FY17F PE of 13x with S$276m cash hoard. 

• We initiate coverage on HRnetGroup (HRnet) with a BUY rating and a TP of S$0.96, pegged at 15x on ex-cash earnings in FY18F, coupled with estimated cash hoard of c.S$275m (estimated ending balance for FY18F). 
• The movements of HRnetGroup's share price post its recent IPO (priced at S$0.90) present an opportunity for investors to buy into this counter as it is now trading at an ex-cash PE of c.13x/ 11x on FY17F/18F EPS, significantly lower than peers.

Labour market has bottomed; recovery bodes well. 

• In addition, our DBS economist believes that the Singapore labour market has bottomed, and is on the cusp of recovery.
• This is premised on the view that job growth tends to lag the services sector by about two quarters; and, the latter seems to have bottomed in 3Q16. With the services sector in the midst of recovery, this augurs well for recruitment firms, and particularly so for HRnet which is the largest player in Singapore.

Largest Asia-based recruitment agency in Asia Pacific (ex-Japan).

• HRnetGroup Limited is the largest Asia-based recruitment agency in the Asia Pacific region, excluding Japan.
• We like this counter for its high ROE and cash generative business, a driven and motivated organisation led by its founder, Mr Peter Sim and his senior management team. With the recent IPO, more than 400 of its employees are now shareholders of the company, which will further spur motivation.

Founded in 1992 with 25 years of operating history. 

• The Group was first founded by Mr Peter Sim in 1992 when HRnetOne Pte. Ltd was set up to provide professional recruitment and flexible staffing services in Singapore, and has since expanded across Asia. 
• As of 30 Sep 2017, the Group has 818 permanent employees, operating through 24 business entities in 10 Asian growth cities, namely, Singapore (location of headquarters), Kuala Lumpur, Bangkok, Hong Kong, Taipei, Guangzhou, Shanghai, Beijing, Tokyo, and Seoul.

Recruitment services industry in Asia Pacific worth S$175bn (by revenue) in 2016, forecast to grow at CAGR of 9.4% till 2021. 

• According to Frost & Sullivan, the Asia Pacific recruitment market for professional recruitment and flexible staffing was collectively worth about S$175.4bn (by revenue) in FY2016. In North Asia (Hong Kong, Taiwan, PRC, Japan and South Korea), the estimated size of the recruitment market is c.S$127.4bn, while that for Rest of Asia (comprising Malaysia and Thailand) and Singapore was worth c.S$5.6bn and c.S$1.3bn, respectively.

Riding on growth in Asian cities. 

• According to Frost & Sullivan, the Asia-Pacific professional recruitment and flexible staffing market (by revenue) is forecast to reach S$274.9bn in 2021 from S$175.4bn in 2016, growing at a CAGR rate of 9.4%.
• Growth is expected to be driven by demand for flexible staffing which is expected to grow by 9.5% CAGR versus professional recruitment at 9.1% CAGR.

Long track record. 

• HRnet has a strong track record with over 25 years of operating history since 1992, establishing new brands and businesses and growing organically. The Group has recorded strong growth and profitability since inception.
• Its 24-year (from 1992 to 2016), 10-year (from 2006 to 2016), and FY2014 to FY2016 CAGRs for revenue were 31.3%, 12.7%, and 6.1% respectively. Its 24-year (from 1992 to 2016), 10-year (from 2006 to 2016), and FY2014 to FY2016 CAGRs for net profit were 40.3%, 14.7%, and 12.9% respectively. This has been achieved through HRnet’s strong relationship with customers, diversified business model across professional recruitment and flexible staffing, and strategic expansion across Asian growth cities.

Co-ownership model, providing incentives. 

• With its recent IPO, the Group has extended its co-ownership model through the 88GLOW and 123GROW incentive programmes, which top management believes will aid in the overall productivity for the Group, align employee interests, and drive better operating performance, thereby contributing to the Group’s growth.
• Both 88GLOW and 123GROW incentive programmes were developed to reward employees. The 88GLOW and 123GROW Plans have 404 employees (as at Sep 2017) that are co-owners of HRnet. The 88GLOW Plan serves to motivate existing co-owners to inspire employees to become Productive Headcount (PHCs), defined as sales consultants who achieve gross profit of at least three times over their gross compensation. 
• HRnet believes that such incentive programmes will be a strong driving force towards achieving even higher productivity as the probability of co-owners interacting and engaging with candidates and clients is higher.

Cashflow generative. 

• Operations are cashflow generative with operating cashflows of c.S$40m to c.S$53m from FY14-16.
• We project the Group to remain in a strong net cash position in FY17F and FY18F given its cash generative business.
• Operating cash flow is projected to remain at c.S$50m in FY18F, after a projected drop in FY17F due to a decrease in accounts payable post payment of accrued dividends.

Growth on expectations of higher productive headcount. 

• We project net profit (attributable to owners of HRnetGroup) growth of c.17% /4% for FY18F/19F, after flat growth in FY17F. The projected growth is driven by increase in gross profit and revenue, and a lower non-controlling interest due to the Group’s 88GLOW plan.
• For FY17F, we are projecting profit after tax and minority interest (PATMI) to dip marginally by 0.2% y-o-y to S$41m from FY16 due mainly to a reduction in “other income”, arising from lower government grants/ wage credits in Singapore, and its IPO expenses (estimated at S$3.6m in FY17F). 
• Excluding the projected one-off IPO expenses, our forecast for FY17F and PATMI would have been about S$44m, registering 7.1% increase from FY16.

Further growth through acquisitions and partnerships. 

• HRnet is looking to grow through acquisitions and partnerships to strengthen its position in existing markets, or to enter into new ones. With projected net cash of c.S$272m by endFY17F, acquisitions may allow HRnet to jump start its entry into new cities and allow HRnet to scale up much faster together with the targets’ existing resources. 
• With partnerships, HRnet could co-operate with players with stronger localised knowledge, deeper experience and track record, or specific specialisations especially in North Asia, and via acquisitions or partnerships with existing players.
• For markets/cities in which HRnet is already present, it plans to explore acquisitions and partnerships in complementary business areas. For acquisition targets smaller in size, HRnet intends to acquire majority stakes and require the existing management to remain as minority shareholders in the business. For acquisition targets that are similar or larger in size, HRnet intends to acquire at least 20% shareholding interest in such targets.

Risks. 

• The risks encompass regulatory, operational as well as macro factors. We highlight that the list is not exhaustive.
  1. Downturn in economic and business cycles affecting job vacancies and recruitment.
  2. Heightened competition, given relatively low barriers to entry, particularly in the Professional Staffing business.
  3. Loss of licence and reputation in the various markets the Group operates in.
  4. Departure of top management and personnel, business management teams, key performers, and consultants, particularly those of Productive Headcount status.
  5. Execution of its inorganic growth initiatives.
  6. Cessation and/or reduced government grants.
  7. Others, including changes in regulations affecting operations, and changes to our forecasts.

Valuation & Peer Comparison 

We initiate BUY on HRnetGroup with a TP of S$0.96 based on a PE valuation methodology. 

• We pegged our valuation to 15x on ex-cash earnings in FY18F, coupled with its estimated average cash horde of c.S$278m (estimated end FY18F). We also cross checked our valuation with the discounted cashflow (DCF) methodology; based on a WACC of 10% and terminal growth of 2.5% post FY22F, our equity valuation stands at c.S$952m, representing S$0.94/share.
• The retreat in share price post its recent IPO (priced at S$0.90) presents an opportunity for investors to buy into this counter as it is now trading at an ex-cash PE of c.13x/ 11x on FY17F/18F EPS, significantly lower than its listed peers of around 16x (ex-cash PE).
• Based on our peer group analysis, we noted that international recruitment peers are trading at a forward PE range of between 13x to 30x, with an average at about 19x.
• Stripping out cash, the ex-cash PE of the peer group stands at around 16x. As such, we believe pegging our TP to 15x on average of FY17F/18F ex-cash earnings, coupled with its estimated average cash balance in FY17F/18F is justified. 
• Our TP implies 23x/ 20x PE on our FY17F/18F earnings. Although this will be slightly above the peer group average, our forecasts have not explicitly factored in inorganic growth from the deployment of its cash.

Company Background 

Largest Asia-based recruitment agency in Asia Pacific (excluding Japan). 

• According to Frost & Sullivan, HRnet Group is the largest recruitment agency based in the Asia Pacific (excluding Japan). 
• As of 30 Sep 2017, the Group has 818 permanent employees, operating through 24 business entities in 10 Asian growth cities, namely, Singapore (location of headquarters), Kuala Lumpur, Bangkok, Hong Kong, Taipei, Guangzhou, Shanghai, Beijing, Tokyo and Seoul.

Started in 1992, with history of 25 years. 

• The Group was first founded by Mr Peter Sim in 1992 under the brand name HRnetOne and provided professional recruitment and flexible staffing services in Singapore. 
• Over the years, it has expanded across Asia, focusing on the growth cities. Currently, it operates in 10 Asian cities. 

Business segments and Geographical areas 

• The Group is organised broadly into two operating segments – Professional Recruitment and Flexible Staffing. 
• As of 1H17, Flexible Staffing contributed about 77% of the Group’s revenue, but accounted for only 34% of the Group’s gross profit. On the other hand, Professional Recruitment accounts for a smaller proportion of revenue (22% in 1H17), but contributed to about 64% of the Group’s gross profit. The main reason for this is due to the cost structure of flexible staffing, where the salaries and wages of the contractor employees paid by the clients are recognised as revenue for the Group. On the other hand, the salaries/ wages paid to the same employees are recognised as cost of sales.
• In terms of geographical area, Singapore accounted for 76% of Group’s revenue for FY16 and 57% of gross profit. The higher percentage of contribution to revenue vis-à-vis gross profit by Singapore compared to the other geographical areas is due to the Group’s Flexible Staffing business in Singapore being larger. 
• On the other hand, Professional Recruitment accounted for the bulk of business in North Asia comprising Hong Kong, Taipei, Guangzhou, Shanghai, Beijing, Tokyo and Seoul, and Rest of Asia comprising Kuala Lumpur and Bangkok.

SWOT Analysis 

Strengths 

• Largest recruitment agency based in the Asia Pacific (excluding Japan) with multiple brands to serve different segments of the manpower recruiting market.
• Strong track record with over 25 years of operating history since 1992, establishing new brands and businesses and growing organically.
• Complementary business model, with the Flexible Staffing business providing the Group with a relatively stable and steady revenue stream even in an economic downturn, and the Professional Recruitment business generally performing well during periods of economic growth.
• Diverse base of clients across 30 diversified sectors, with Top 5 and Top 10 clients respectively accounting for 14.1% and 20% of Group revenue in 2016, respectively.
• Large scale provides position of strength, particularly for Flexible Staffing where the agency acts as the employer and pays wages and salaries for contractor employees, and billing corporate customers thereafter.
• Ability of management to adapt to the change in needs, nature and composition of the labour market to suit clients’ requirements.

Weakness 

• Highly dependent on consultants in driving sales and topline growth. The management and achievement of a high percentage of sales personnel being productive headcount (in respect of a sales personnel, this is defined as those who have achieved gross profit of 3 times his/her fixed salary) is essential in driving growth and profitability for the Group. Departures of performing key individuals and/or group of consultants may have an impact on the Group’s operating performance.
• Despite a long operating history, growth has been achieved via organic routes. HRnet may not possess the required experience to pursue inorganic growth through acquisitions and strategic alliances.

Opportunities 

• Expect economic growth in Asian cities to lead to an increase in demand for staffing, which in turn presents opportunities for recruitment agencies.
• Strong cashflow generation enables Group to pursue inorganic growth opportunities such as strategic acquisitions and/or partnerships in new or existing markets.
• Opportunity to further improve and extract efficiency in its various offices to enhance margins for the Group, particularly with its co-ownership business model and lean corporate structure.
• Taps on co-ownership model to drive performance of its consultants through the implementation of its 88GLOW and 123GROW incentive programmes.

Threats 

• Low barriers to entry for new entrants in Professional Recruitment segment which could result in price competition and thus resulting in clients switching to other competitors.
• Regulatory framework changes, breach of laws and regulations as well as complaints may affect operations and brand reputation of the various recruitment agencies under the Group’s umbrella.
• Downturn in economy and employment, causing placement opportunities to drop, and corporates turning to more cost conscious initiatives, such as internal talent acquisition team (for large corporations). While the Group’s performance may be mitigated partially by its exposure in the Flexible Staffing segment, its overall performance may still be impacted.
• Cessation and/or changes to government grants may impact financial performance.

Andy SIM CFA DBS Vickers | Alfie YEO DBS Vickers | http://www.dbsvickers.com/ 2018-01-03

DBS Vickers SGX Stock Analyst Report BUY Initiate BUY 0.96 Same 0.96