HRNet: Almost antifragile

“Antifragile” as defined by Nassim Taleb refers to something which gets stronger during disorder. I think HRNet almost fits this description so I bought more HRNet shares after the company reported surprisingly resilient 2020 results. Healthy flexible staffing business resulted in revenue growing 2% and recurring net profit falling 4% during 2020 while operating cash flow grew 76%. With its resilient business model, I think HRNet is a cheap and safe way to bet on a V-shaped economic recovery in 2021 and secular growth in Asia.

HRNet is a Singapore-based staffing company with high returns on capital and a cheap valuation. Staffing and recruitment is a tough business but HRNet is laser-focused on profit margins with ROA averaging 12% respectively over 2018-20 and cheap with the company trading at only 3.8x trailing EV/EBITDA while net cash makes up 57% of its market capitalization.

Why is HRNet undervalued?

Small cap stock: SGD586 million market cap

Listed in Singapore

Broken IPO with the company listed in 2017.

Limited sell-side coverage with only 3 analysts covering the stock.

Company overview

HRNet has two main segments – Flexible Staffing and Professional Recruitment.

Flexible staffing (83% of revenue and 44% of gross profit in 2020) involves HRNet deploying contractor employees for clients in Singapore, Taipei, Hong Kong, Kuala Lumpur and Shanghai.  HRNet charges a fee covering contractor pay and a typical 15% gross margin.  Flexible staffing is less profitable than professional recruitment but is resilient during recessions with the company’s flexible staffing revenue grew 10% in 2020.

Professional Recruitment (17% of revenue and 56% of gross profit in 2020) charges a fee to clients for successful permanent job placements based on a percentage of the candidate’s first year remuneration.   This business does not incur direct cost of sales for permanent job candidate placements resulting in a ~ 100% gross margin and 25% net margin. However, professional recruitment fees are lumpy and dependent on economic growth with this segment’s revenue falling 24% in 2020.

Here are a few reasons why HRNet should do well over the next 5 years.

HRNet’s scale provides breadth and depth

Staffing and recruitment has low barriers to entry but the company’s scale does provide some advantages over smaller competitors. HRNet has specialized industry teams, the reach to support multinational companies across multiple locations and the balance sheet to support payroll requirements of customers with large flexible staffing requirements.

The company’s large recruitment workforce also provides both breadth and depth in its industry coverage with the company organizing its 900 recruitment consultants into 22 industry specializations with a high level of detail. For example, consultants covering financial institutions are organized into teams covering front, middle and back office roles and even within the front office roles, HRNet has teams focusing on only hiring relationship managers and investment bankers. HRNet’s recruitment consultants are expected to know their respective industries comprehensively which include suitable candidates for various roles so they only need to check in with a candidate upon securing a client order.

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. HRNet’s flexible staffing business requires SGD100 million of working capital to support its large flexible staffing workforce because the company is required to pay its contractor employees first and will only be paid by its clients 60 days later. HRNet’s flexible staffing focus during the 2020 recession and pandemic allowed the company to pivot to sectors such as healthcare and supermarkets which needed more temporary workers. In 2020, “Singapore’s largest supermarket” (NTUC Fairprice) became HRNet’s largest customer (4% of 2020 revenue) probably because of HRNet’s involvement in supplying temporary contractors to their supermarkets.

HRNet’s exposure across many industries has allowed the company to diversify revenue sources with the company’s top 10 clients making up 22% of revenue. None of the clients also make up more than 5% of total revenue and no industry contributes more than 20% of total revenue. HRNet serves nine main sectors including retail, technology, financial institutions, healthcare, manufacturing, insurance and logistics. In 2020, the company’s largest source of revenue was from the government sector which made up 17% of its annual revenue. The company’s major clients include multinational corporations such as Samsung Electronics, HSBC and DBS Bank. HRNet’s top 5 clients have worked with the company for an average of 17 years which speaks well of their service quality.

Normalizing economic conditions and international growth

Singapore made up 55% of gross profit in 2020 while North Asia (eg. Hong Kong, Taipei and Shanghai) contributed 42% with the remaining 3% derived from other Asian cities.

Singapore, HRNet’s largest market is expected to grow GDP by 4-6% in 2021 after contracting 6% in 2020 so this should lead to increased hiring opportunities. There are signs that the Singapore economy has bottomed out. Singapore’s resident employment levels rebounded to pre-COVID levels by end-2020 and the overall unemployment rate fell for the second consecutive month in December 2020 to 3.2%. Technology (14% of 2020 revenue) and financial institutions (14% of revenue) are the second and third largest source of revenue for HRNet and both industries are increasing hiring activity. Zoom Video said in December 2020 that it will establish a Singapore R&D hub and will hire “hundreds” of engineers. Meanwhile, Singapore’s central bank awarded four new digital bank licenses in December 2020 with the Singtel-Grab digital bank announcing plans to hire 200 roles in 2021.

China and Taiwan, two key HRNet markets, are recovering nicely with unemployment rates in Taiwan already trending below pre-pandemic levels as of end-2020. Meanwhile, China’s unemployment rate as of end-2020 was 5.2% in December 2020, unchanged from 2019 levels.

Can a foreign company like HRNet do well in the competitive North Asia market? Consider Manpower Group, a US staffing company operating in Greater China. ManpowerGroup Greater China was listed separately in Hong Kong during 2019 with the company starting recruitment services in Hong Kong and Taiwan during 1997 and in mainland China in 2003. The company currently serves 130 cities in Greater China with revenue growing 11% year on year to RMB1.6 billion during the first half of despite a global pandemic and recession. Manpower Group’s successful growth record in the Greater China region is a good sign for HRNet’s expansion efforts in North Asia.

HRNet intends to grow by focusing on North Asian cities such as Hong Kong, Shanghai, Beijing and Tokyo. The company has a proven record of international expansion with the company growing from its Singapore origins in 1992 to its current presence in 13 Asian cities by relying on its strong relationships with multinational companies with regional headquarters in various cities. HRNet’s North Asia revenue and gross profit has compounded at 8% and 3% respectively from the 2014 to 2020 period. 

In Japan, HRNet is well placed as their expertise in healthcare life science (which usually contributes the largest portion of revenue) is expected to be in demand due to the ageing population. HRNet also has a frame agreement with TechnoPro, the largest Japanese engineering staffing firm to support Japanese multinational companies operating in Asia.

Unique and cost conscious culture

HRNet’s culture and process-driven workflow is 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. This profit sharing model results in a more collaborative and cost efficient culture which explains the company’s consistent track record in profitability.

The company is focused on reducing overhead costs with no receptionists or personal assistants in its headquarters or offices and 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 within their specialization, sending 10 candidate profiles to clients and to arrange three job interviews per week. Internal meetings are held on Saturdays allowing employees to focus on meeting candidates and clients during weekdays.

This frantic pace of work isn’t for anyone and attrition is high for consultants during their early years with only 30% out of 124 reviewers on Glassdoor.com recommending the company as a place to work. However, the company’s focus on sales has been effective with Productive Headcount (employees who bring in gross profit in excess of 3 times of their payroll cost) making up 63% of its sales employee headcount. Those who excel and who thrive in this sales-oriented environment stay for a long time. In a 2018 interview with the Business Times, HRNet said that the company does have 145 team leaders who have averaged more than 10 years of service with the company.

Proven ability to grow

HRNet was listed in 2017 so the company only has a short track record as a listed company.

HRNet	Revenue (SGDm)	Reported net profit (SGDm)	Recurring net profit (SGDm)	Operating cash flow (SGDm)	Free cash flow (SGDm)	Net cash (SGDm)	ROA
2014	324	33	33	40	39	123
2015	356	39	39	50	49	120	20%
2016	365	41	41	53	53	106	15%
2017	392	41	41	35	34	289	10%
2018	429	48	47	52	50	281	12%
2019	423	52	50	59	58	266	12%
2020	433	47	48	104	103	332	11%

Three things stand out when assessing the company’s financial performance:

First, the company has a decent track record of growing through economic cycles with no debt. HRNet said in its IPO prospectus that it has been profitable since its 1992 inception apart from a small net loss in 1998. The company has an impressive growth track record with revenue and net profit compounding at 31.6% and 39.5% over the 1993-2016 period.

Second, growth has slowed since the company’s listing with the company’s Singapore business hit by lower professional recruitment activity. Despite this headwind, revenue, net profit and free cash flow has compounded at 3%, 4% and 44% respectively over the 2017-20 period. The company’s performance during 2020, a year marked by a global pandemic and recession has been impressive with revenue growing 2% and free cash flow expanding 76% because of working capital improvements. Excluding working capital changes, operating cash flow grew 6% in 2020.

Lastly, the company’s balance sheet is rock solid with no debt and SGD332million of net cash as of end- 2020. Shareholder dilution has also been minimal since IPO with the company’s diluted share count increasing only 3% per year over the 2017-20 period.

Management is aligned with shareholders

HRNet is 74% owned by the Sim family which includes the 67 year old founder, Peter Sim, the company’s chairman and his daughter, Adeline Sim (40 years old), the company’s Chief Legal Officer so management clearly has skin in the game. Succession planning is well underway with Adeline Sim currently sitting on the board of directors.

HRNet’s best recruitment consultants are also given a chance to invest in the company with 27% of its permanent employees or 254 employees involved in this program. Participants buy shares at market price in return for which they would receive bonus shares over a 3-year period provided they continue to bring in gross profit in excess of 3 times of their payroll cost. This profit sharing model scheme works with employees involved in this ownership scheme having an overall 84% retention rate.

Valuation

At its current SGD0.60 price, HRNet is cheap with the company trading at only 3.8x trailing EV/EBITDA and 12.8x trailing P/E. I’ll focus on EV/EBITDA because of the company’s large cash position.

HRNet wasn’t always so cheap. The company traded at 9x trailing EV/EBITDA for most of 2018. With HRNet delivering revenue and free cash flow growth in 2020 and a 12% return on assets during a global pandemic and recession, the company probably deserves a higher multiple.

Larger US peers such as Robert Half, Manpower Group, Kelly Services and Korn Ferry trade at 11x trailing EV/EBITDA with a 5% return on assets while Asian peers such as Technopro and Persol and Beijing Career average 20x trailing EV/EBITDA with return on assets averaging 7%.

Investors are also being paid to wait for a recovery with HRNet’s trailing dividend currently yielding 4.1% and the company usually paying out around 50% of earnings.

Risks

Bad acquisitions are a key risk given that HRNet generates huge amounts of free cash flow. Bears point to HRNet’s recent SGD55 million acquisition of a 29% stake in Staffline, a UK flexible staffing company which has been suffering from declining revenue and profit. This acquisition is balanced by the company’s cautious approach of buying minority stakes in recruitment companies and their preference for founders to maintain an ownership stake in the acquired company.

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 has stayed 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

In short, HRNet is a fair company trading at a wonderful price with the company trading below its historical range and peers. The resilience of HRNet’s cost-focused culture and its combined recruitment and flexible staffing business has been proven after the company survived a global pandemic and recession with minimal declines in revenue and free cash flow. HRNet has also achieved scale and deep specializations in various Asian growth cities and is well placed to capitalize on a global economic recovery with its strong balance sheet.