HRNet: Perfect fit

HRNet is the largest staffing company in Singapore and has a company culture which is laser-focused on maximising profits.With the company present in 13 Asian growth cities and a 24 year track record of profitable operations, this growth company should be a perfect fit for my income portfolio.

The company’s annual report is well written, focused on shareholder-friendly growth and reminds me of great companies like Berkshire Hathaway, Amazon and Netflix.

HRNet’s story began in 1992 with the company growing from a 4 man team in a 300 square feet office to over 1,000 employees in 2018 across 10 Asian growth cities.

HRNet financials

Revenue (SGDm) Net profit (SGDm) Operating cash flow (SGDm) Free cash flow (SGDm) Net cash (SGDm) Net margin
2014 324 33 40 39 123 10%
2015 356 39 50 49 120 11%
2016 365 41 53 53 106 11%
2017 392 41 35 34 289 11%
9M18 320 42 39 38 275 13%

HRNet 20 year history

HRNet was listed in 2017 so the company has a relatively short track record but in its IPO prospectus, the company did disclose that it has been profitable over its 24 year history.

A few things stand out:

  1. Net profit has been growing at double digit rates over its 24 history despite short-term blips caused by recessions.
  2. Profit margins have been growing steadily from 10% in 2014 to 13%.
  3. Operating cash flow and free cash flow has grown at similar rates because recruitment companies have minimal capital spending.
  4. The company’s balance sheet is rock solid with no debt and SGD275 million of net cash as of end September 2018.

In 2017, net profit was hurt by  SGD3.6 million in IPO expenses, and S$4.4m fall in government subsidies. If these items are excluded, 2017 net profit would have grown at a healthy 15.4%.

Why HRNet will grow at 10-15% annually over the next five years

HRNet benefits from economies of scale which is a moat that is likely to expand with the company’s growth. Technology and administrative costs are centralized in its Singapore head office which implies infrastructure and technology costs will increase at a slower pace compared to revenue. As a result, the company’s profit margin will increase as its business expands.

The company’s large recruitment workforce also provides both breadth and depth in its industry coverage with the company being able to cover a wide range of industries with a high level of detail. In Singapore, the company’s flexible staffing position is so strong that some of its flexible staffing candidates come in the morning for an interview and leave with a job by the end of the day.

Meanwhile, the company’s exposure across many industries has allowed the company to diversify revenue sources with no client making up more than 5% of total revenue. In 2017, the company’s largest source of revenue was from financial institutions which made up 18% of its annual revenue. The company’s major clients include multinational corporations such as Samsung, Singtel and HSBC.

2017 HRNet revenue

2017 HRNet revenue

Lastly, flexible staffing services require substantial working capital requirements which smaller firms cannot provide as the company is required to pay its contractor employees first and will only be paid by its clients 60 days later.

HRNet’s culture and process-driven workflow is also special. Unlike other recruitment firms, HRNet does not pay sales commissions to recruiters. Instead recruiters are rewarded based on a profit-sharing model which results in the company focusing on profitability rather than market share.

The company is focused on reducing overhead costs with no receptionists or personal assistants in its headquarters or offices. I visited the Singapore headquarters and didn’t see any receptionist there.

Receptionist

In fact, 85% of the company’s workforce consists of its salesforce. Recruitment consultants use the company’s “10-10-3” workflow which involves meeting 10 candidates, sending out 10 candidate profiles to clients in order to achieve three placements per quarter. Internal meetings are held on Saturdays which allow employees to focus on meeting candidates and clients from Monday to Friday. This focus on sales and cost has been effective with the company’s Productive Headcount (employees who bring in gross profit in excess of 3 times of their payroll cost) making up 66% of its sales employee headcount.

HRNet has a large addressable market. The company derives 58% of its gross profit from Singapore and 38% from North Asia. In Singapore, its largest market, HRNet is the market leader with a 20% market share in 2017 so there is still room for growth. In Japan, HRNet’s focus on the hospitality and retail industry is well placed to meet the higher staffing demand from the upcoming 2019 Rugby World Cup and 2020 Olympic Games in Tokyo.

HRNet is also well placed to grow in North Asia which is a large and rapidly growing market. The North Asia recruitment and flexible staffing market is estimated to be a SGD46 billion market in 2016 and is estimated to grow 11.5% annually from 2016 to 2021 based on a Frost and Sullivan report.

Ownership

HRNet is 74% owned by the Sim family which includes Peter Sim, the company’s founder chairman and Adeline Sim, the company’s Chief Legal Officer so management should be aligned with shareholders.

HRNet’s shareholders also includes 404 of its employees which have contributed to profits through its 123Grow scheme. Participants buy shares at market price in return for which they would receive bonus shares over a 3-year period provided they continue to contribute profits. The company’s co-ownership scheme works. Of the 404 co-owners, employee retention rate is 90%, and of that number, 97% are Productive Headcount (bringing in gross profit in excess of 3 times of their payroll cost).

Valuation

At its current SGD0.80 share price, HRNet is trading at 15x trailing earnings which seems like a fair price to pay for a 10-15% growth company. The company intends to distribute 50% of its recurring net profit in 2018 as a dividend.

Based on a comparison with other staffing companies, investors may be under-valuing the ability of HRNet to grow for many years. Consider Robert Half and Adecco. Robert Half and Adecco are two of the largest staffing companies in the US and Europe respectively. Each of these companies is more than 10x larger than HRNet but both have grown dividends at a healthy rate. Robert Half’s dividend has grown by 11.6% per year since its first 2004 dividend while Adecco’s dividend has grown by 7.9% annually over the 2005-17 period.

Here are my valuation assumptions:

  • Trailing 12 months EPS is SGD0.05
  • 14% growth rate in EPS from 2019 to 2023 (similar to historical 10 year growth rate)
  • TTM PE multiple drops to 13x
  • Value per share works out to SGD1.3 (~70% upside)

Risks

HRNet benefits from government subsidies so the removal of these subsidies could result in a one-off drop in profits. In 2017, these subsidies made up 10% of net profit.

The company’s revenue and net profit is also vulnerable to economic recessions where companies may cut back on hiring activities. However, the company’s flexible staffing business provides employers with an option to hire on a variable cost basis so this business is likely to stay resilient during recessions.

The growing popularity of Linkedin could also be a threat with some employers hiring candidates directly using the platform. HRNet’s ability to provide employers with comprehensive “talent landscape” maps and their deep industry knowledge should be a mitigating factor.

 Conclusion

HRNet’s scale advantages, 24 year track record in profitable operations and a culture focused on shareholder friendly growth is a winning combination in the competitive staffing industry. With the company having a SGD275 million war chest for acquisitions and its expansion into other Asian growth cities, the company is likely to generate 10-15% growth in operating cash flow and dividends for many years.

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