HRnetGroup Limited - CGS-CIMB Research 2018-09-25: Best Candidate In Town

SGinvestors.io

HRNETGROUP LIMITED SGX:CHZ

HRnetGroup Limited - Best Candidate In Town

• HRnetGroup is the only listed proxy for labour markets in Singapore & China. 
• We like its asset-light and fairly-defensive business model, with the twin earnings growth engines of professional recruitment and flexible staffing. 
• Net cash of S$270m (at end-2Q18) available to fund North Asian expansion. Potential 16-22% upside to FY19-20F EPS from M&As not factored in. 
• We initiate coverage with ADD and Target Price of S$1.10, pegged to 18x CY20F P/E.

BUSINESS OVERVIEW

• HRnetGroup is the largest recruitment agency in Asia ex-Japan and has operations in 12 major cities across the region (Singapore, Kuala Lumpur, Bangkok, Hong Kong, Taipei, Guangzhou, Shanghai, Beijing, Tokyo, Seoul, Jakarta and Suzhou). It serves more than 2,000 clients in 30 different sectors. According to Frost & Sullivan, HRnetGroup is the largest player in the recruitment services space, commanding more than 20% market share (based on 2015 revenue) in Singapore.
• HRnetGroup’s key brands are HRnetOne, Recruit Express and PeopleSearch.
• HRnetGroup serves clients in a wide range of industries and its operations can be divided into two main business segments – flexible staffing (77% of FY17 revenue) and professional recruitment (22%).

~ SGinvestors.io ~ Where SG investors share

COMPANY OUTLOOK

Improving productivity of sales consultants to underpin organic revenue growth

• As a provider of professional services, HRnetGroup’s employee productivity is a key performance indicator and has significant impact on profitability. Productivity is measured as the employees’ ability to generate gross profits, in the form of placements, to cover their salaries. To be considered a Productive Headcount (PHC), employees have to bring in 3x their salary in gross profit each month. Sales consultants are incentivised to attain the status of PHC in order to qualify for profit-sharing and various employee share award schemes.
• In 1Q17- 2Q18, the group’s employee productivity has improved in terms of both revenue per sales employee and the PHC rate (number of PHC as a percentage of total staff headcount). ~ S G investors . io ~ Where SG investors share
• Profit sharing, as opposed to sales commission, ensures that employees work towards raising overall profitability for the group and keeps business unit morale positive. Management also revealed that its profit-sharing schemes also encourage teams to collaborate on deals, which improves overall productivity. The introduction of performance-linked co-ownership schemes (123Grow Plan and 88GlowPlan) has resulted in more than 400 of its employees (currently 786 permanent employees in total) becoming shareholders of the company.
• We expect the group’s profit-sharing and co-ownership schemes to enhance the productivity of its sales force, driving topline growth for the group moving forward.

Increasing focus on flexible staffing

• With the professional recruitment segment facing limited growth potential due to the possible slower economic growth in Singapore in 2019, we expect HRnetGroup’s focus to shift towards the flexible staffing business, as it is less vulnerable to the business cycle and provides cash flow stability. Management plans to introduce the RecruitFirst brand in Shanghai and launch the HRnet One brand in Shenzhen to focus on recruitment in the Artificial Intelligence (AI) sub-sector. As of 1H18, HRnetGroup had approximately 9,000 contract employees in Singapore and 2,000 contract employees in Hong Kong, Kuala Lumpur and Taipei.
• In addition, we think the group’s flexible staffing business is a beneficiary of new businesses looking to scale up quickly. HRnetGroup was able to handle the employment of approximately 300 support staff for Uber Singapore, when the company wanted to expand operations quickly from 2013-2017. When Uber exited Singapore, this contract was replaced by a contract of similar size from the Ministry of Education.
• HRnetGroup’s strong balance sheet and staff strength make it one of the few executive search firms in Singapore capable of coping with the additional working capital needed for expansion of flexible staffing.

Further penetration of high-growth Asian cities

• HRnetGroup’s first foray into Mainland China was in 2006, when it launched its HRnetOne brand in Shanghai, followed by expansion to Beijing and Guangzhou. Singapore represented 76% of group revenue and 58% of gross profit in FY17. However, we project that North Asia will become a bigger revenue and gross profit contributor moving forward, as the group builds its presence via the expansion of existing brands and M&As.
• In Jan 2018, HRnetGroup acquired a 51% stake in REForce (Shanghai) Human Resources Management Consulting Co Ltd (Unlisted), a Chinese recruitment agency that operates in the professional recruitment segment, with offices in Shanghai, Beijing, Guangzhou and Suzhou. This raised the group’s total staff headcount in China to 187 in 3Q18 from 119 previously.
• HRnetGroup also acquired 100% of Career Personnel Limited in Aug 2018. Given its track record of providing about 130 contract employees to the government every year over the past four years (2014-17), we think the 26-year-old company could accelerate RecruitFirst Hong Kong’s (two years old) revenue growth and help it to break into the flexible staffing market.

Clear strategy for M&As and overseas expansion

• With its IPO net proceeds of S$165m, HRnetGroup has been on the lookout for opportunities to strengthen its position in existing markets or enter new ones, particularly high-growth cities in Asia. ~ S G investors . io ~ Where SG investors share
• According to HRnetGroup, any strategic acquisition or partnership would have to fulfill the following criteria:
  1. at least 1,000 contractors in one location (for any first-tier city in China or Japan) for flexible staffing business or at least 30 consultants in one location for professional recruitment business,
  2. HRnetGroup to acquire a majority stake, with the core management team staying on as minority shareholders, and
  3. earnings-accretive business, with P/E multiples of 5-15x taking reference from earlier deals. 

FINANCIALS

Forecast net profit to expand by 14.6% CAGR in FY17-20F

• HRnetGroup’s topline growth was historically led by the flexible staffing segment, due to slower labour markets negatively affecting the professional recruitment segment. This was especially the case in FY17, when its number of contract employees swelled by 800 to 11,300 thanks to the influx of technology companies in Singapore. 
• HRnetGroup’s 1H18 net profit surged 58.5% y-o-y on the back of 11.5% revenue growth and a 0.9% pt improvement y-o-y in gross margin.
• Our projection of 6.3% revenue CAGR over FY17-20F is derived from flexible staffing volume growth and greater synergies from recent acquisitions. This, together with the increasing productivity of sales consultants and higher operating leverage, should offset the decline in government grants and cause net margin to increase from 11.9% in FY17 to 14.2% in FY20F, translating into net profit CAGR of 14.6%, based on our estimates.

M&As to provide net profit upside of 16-22%

• We estimate that HRnetGroup only has working capital requirements of c.S$100m p.a. in FY18-20F, leaving a sizeable cash pile of S$180m (excluding estimated working capital needs) at end-2Q18 for M&As. Assuming an all-cash deal and acquisition P/E multiples of 11-15x over the next two years, we estimate M&As to boost our FY19-20F net profit forecasts by 16-22%.
• For bigger-sized deals, we do not rule the possibility of new share issuances, as the founding Sim family is open to stake dilution up to 51% (current: 74%).

Reducing reliance on government grants

• Due to the high proportion of wage-related costs (~82% of revenue earned in FY17), HRnetGroup receives substantial Singapore government grants (Wage Credit Scheme, WCS, Special Employment Credit Scheme, SEC, and Temporary Employment Credit Scheme. TEC), amounting to S$8.1m in FY15, S$11.4m in FY16 and S$6.3m in FY17. Assuming no further extension to the three schemes, we project HRnetGroup’s income from government grants to gradually decline with the end of the TEC in 2017, SEC in 2019F and WCS in 2020F.
• With the consolidation of new acquisitions and organic growth, we think that HRnetGroup would be less reliant on government grants to sustain earnings moving forward.

Cash-generative business with clean balance sheet

• At end-2Q18, HRnetGroup was in a net cash position of S$270m (S$180m excluding estimated working capital needs) with zero borrowings; its net cash per share of S$0.27 at end-2Q18 makes up ~30% of its current market cap. Given its fairly short cash conversion cycle of 55 days on average (credit terms of 7-60 days typically), HRnetGroup has consistently generated positive operating cash flow of S$35m-53m in FY14-17.
• We note that its investments were limited to S$2.0m p.a. in FY14-16, although this rose to S$5.3m in FY17 resulting from its purchase of marketable securities. 

Guidance for dividend payout of 50% in FY18F

• HRnetGroup declared a DPS of 2.3Scts in FY17, representing dividend payout ratio of 50.1%.
• With its cash-generative business, strong balance sheet and minimal capex needs, we expect this dividend payout ratio to be sustainable, translating into FY18-20F dividend yields of 3.0-3.5%. ~ S G investors . io ~ Where SG investors share

VALUATION AND RECOMMENDATION

Initiate coverage with ADD and a target price of S$1.10

• We initiate coverage on HRnetGroup with an ADD rating and target price of S$1.10, based on CY20F P/E multiple of 18x (the average of its global peers).
• We view the company as a proxy for economic and labour market growth in Singapore and China. We like its asset-light, cash-generative business model and unique ownership scheme to ensure staff retention. Its strong sales force and balance sheet (S$270m net cash at end-2Q18) make it one of the few staffing solution players in Asia that large clients can work with, particularly on flexible staffing.
• HRnetGroup currently trades at 15.1x CY19F P/E (9.6x ex-cash), at an almost 50% discount to its North Asian peers’ average and at a 20% discount to its global peers’ average. We think the discount will narrow as the company increases its regional presence and pursues synergistic M&As with its S$180m cash pile (excluding working capital requirements) at end-2Q18.

Refer to the attached 32-page PDF report for complete analysis.

NGOH Yi Sin CGS-CIMB Research | https://research.itradecimb.com/ 2018-09-25

SGX Stock Analyst Report ADD Initiate ADD 1.10 Same 1.10