HireQuest: Trading At A Premium Multiple For A Reason (NASDAQ:HQI)

The key relating to HireQuest, Inc. (NASDAQ:HQI) is out. It operates the next margin enterprise mannequin, it’s run by proprietor operators with a historical past of good capital allocation, and it has a protracted runway for development because it continues to consolidate the fragmented staffing trade.

I say the key is out as a result of the inventory has gone up greater than 100% over the previous 12 months, partly attributable to earnings development but in addition due largely to a number of growth. In that point HireQuest’s GAAP EV/EBIT a number of has elevated from 12x to 24x. Even when utilizing HireQuest’s trailing twelve months adjusted EBITDA of $21.4m which subtracts stock-based comp and costs associated to the latest acquisition, the a number of continues to be fairly excessive.

Does HQI deserve a premium a number of over its friends? I believe it does. Its franchise mannequin is larger margin and results in recurring income streams which can be extra predictable. Along with this, the corporate has a historical past of buying smaller staffing firms and integrating them into HireQuest’s ecosystem very effectively. Consolidating the staffing trade is what is going to result in long-term development so the flexibility to do that successfully deserves a premium. This environment friendly integration of acquisitions is largely attributable to an skilled CEO and administration staff that additionally owns a big portion of HireQuest’s fairness. Good capital allocation with aligned administration completely deserves a premium.

However I’m additionally cautious of simply how giant that premium is over its trade friends. Earnings multiples are capabilities of return on invested capital (ROIC), development, value of capital and tax charges. When evaluating multiples between firms throughout the identical trade, value of capital and tax charges are usually related so development and ROIC would be the principal drivers of its a number of in comparison with trade friends.

When taking these components under consideration, I believe HireQuest deserves to be buying and selling at a premium. On this article, I’ll go into extra element on why that is the case. I’ll evaluate development, ROIC and return on incrementally invested capital (ROIIC) between HireQuest, Robert Half Worldwide Inc. (RHI), and Heidrick & Struggles Worldwide, Inc. (HSII), two friends throughout the staffing trade.

HireQuest’s Differentiated Enterprise Mannequin

HireQuest differs from most different giant publicly traded staffing firms in that it practices a franchise mannequin. This results in many advantages together with higher expense management, extra aligned incentives with operators of the franchises and extra of a recurring stream of income. This additionally works properly with an acquisition mannequin because it makes integrations of latest acquisitions far more simple and price environment friendly.

This isn’t solely true in principle however has been confirmed in apply. HireQuest has a historical past of incomes excessive returns on acquisitions up thus far and the low value mannequin was particularly useful in 2020 throughout the peak of the pandemic as they maintained a excessive working margin regardless of a decline in income.

Along with the enterprise mannequin that enables for these efficiencies, HireQuest’s CEO, Rick Hermanns, has years of trade expertise and a historical past of constructing good acquisitions as seen by the incredible monetary outcomes over the previous few years. Since 2019, income has grown at a 24% CAGR, working earnings has grown at a 20% CAGR and the share rely has solely grown at 5% CAGR. The very best half about this efficiency is that it is an asset-light enterprise and there may be little to no upkeep capital expenditures required to take care of these earnings. Which means these earnings convert very properly to free money movement.

To proceed rising nevertheless, they might want to spend money on acquisitions. However so long as the return on these acquisitions continues to be properly above and past the price of capital, administration is creating worth for shareholders.

The market has acknowledged this worth creation because the inventory has risen 300%+ because the finish of 2019. That is partly because of the development in earnings per share mentioned above but in addition attributable to a number of growth. In mid-2020, HireQuest was buying and selling at a trailing 12 month GAAP EV/EBIT ratio of round 10 in comparison with the present GAAP EV/EBIT of 25. The present ratio consists of one-off costs associated to the latest MRI acquisition, however even when we add again these bills, the present EV/EBIT ratio is 21.5. I’ll go into why this a number of is deserved beneath.

Valuation

As I discussed above, earnings multiples are decided by development, ROIC, value of capital and taxes. As a result of value of capital and taxes are usually related amongst friends from the identical trade, the distinction within the earnings a number of between HireQuest, Robert Half and Heidrick & Struggles needs to be largely decided by development and ROIC.

The next are the trailing 12 month GAAP EV/EBIT multiples for the three firms:

Click on to enlarge

I already described HireQuest’s development and ROIC story above, so I’ll briefly contact on Heidrick & Struggles, and Robert Half beneath. As a be aware, all of my ROIC calculations embrace goodwill and different intangible property as acquisitions are a vital a part of development for these companies.

Heidrick & Struggles

In 2022, I calculated Heidrick & Struggles’ ROIC to be 21%. Whereas this seems excessive, a lot of this return is predicated on outdated property that earn excessive returns. Not too long ago, the corporate has been increasing into new segments moreover staffing and these new segments are dropping cash.

All the latest acquisitions have been going in the direction of these newer segments so though ROIC is excessive attributable to older property producing excessive returns, returns on new acquisitions are far beneath the price of capital and destroying worth for shareholders. Together with this, income and earnings declined in Q1 2023.

The market acknowledges the low development forward and the chance that worth destructing capital allocation selections will proceed and is appropriately assigning a low a number of to the inventory. That is even though they grew income and earnings from 2019-2022.

Robert Half

For 2022, I calculated Robert Half’s ROIC to be 47%. That is very excessive. Income has grown at a 5% CAGR since 2019 however earnings have grown at a 15% CAGR in that very same time so a lot of the earnings development has come from margin growth. Nonetheless in Q1 2023, income declined 5% 12 months over 12 months whereas earnings declined 27% so plainly no matter working leverage Robert Half has gained over the previous few years reversed fairly shortly.

Regardless of the historical past of a excessive ROIC, the market is seeing the income decline and earnings decline which is able to result in decrease ROIC going ahead. No development and decrease ROIC, regardless of being above the price of capital, results in a decrease a number of.

Evaluating the Three

I calculated HireQuest’s 2022 ROIC to be 46%, the identical as Robert Half’s and far larger than Heidrick & Struggles. Nonetheless HireQuest noticed 30% 12 months over 12 months income development in Q1 2023 in comparison with a decline in income for the others. This development got here with a decline in earnings because of the integration of the latest acquisition, MRI, however administration claims that these inefficiencies will likely be resolved. The market clearly believes this given the at the moment excessive a number of.

Time will inform if this a number of is warranted. There’s some probability of an upcoming crack within the labor market and if this weak spot results in a decline in earnings for HireQuest, I count on its earnings a number of to right and the inventory to drop in an enormous approach as it’s a giant divergence from what the market expects. Nonetheless, if HireQuest can proceed to develop because it has prior to now regardless of labor market weak spot, combine MRI successfully, and proceed to make acquisitions at a excessive price of return, this inventory seems undervalued.

For a worth goal, I’ll create three eventualities for EBIT and an EV/EBIT a number of in 2025, assign a chance to every and add the anticipated values. Within the first, HireQuest grows EBIT at 10% per 12 months and finally ends up with a EV/EBIT a number of of 15. Within the second, EBIT grows at 15% and the ultimate a number of is 20. And third, EBIT grows 20% per 12 months and the ultimate a number of is 25. The enterprise values within the eventualities are $335m, $510m and $725m respectively.

Assigning a 50% chance to the ten% development state of affairs, a 30% chance to the 15% development state of affairs and a 20% chance to the 20% development state of affairs results in an anticipated enterprise worth of $465m. In comparison with the present $339m EV this doesn’t present enough returns to warrant an funding.

I’m assigning the next chance to the bottom development state of affairs to be conservative and to account for what I consider is a excessive danger of labor market weak spot within the second half of this 12 months and in 2024. When you disagree with that, you could assign totally different possibilities. However the principle level I’m attempting to make is that I do not assume an funding on the present a number of of earnings gives sufficient reward for the potential danger of a foul recession.

Ultimate Ideas

HireQuest trades at a premium a number of in comparison with its friends. This premium is because of the market believing that HireQuest will be capable to develop and keep a excessive ROIC going ahead regardless of any labor market weak spot that could be upcoming.

I personally do not feel comfy constructing a place in HireQuest whereas it trades at this premium a number of. I perceive people who want to maintain it if they’ve owned it for a while however I do not assume an funding at this a number of compensates me sufficient for the chance of a foul recession that might trigger a spike in unemployment thus a decline in HireQuest’s earnings. Nonetheless, I perceive the standard of HireQuest’s enterprise mannequin and the standard of its administration staff so I’ll absolutely revisit if the a number of declines or if that unhealthy recession happens.

I could miss out on good returns over the following few years by not investing now however I do not assume the chance/reward is in my favor at this level, given the potential upcoming financial dangers.

Sarcastically, a foul recession could also be good for HireQuest in the long term as it can permit them to amass struggling staffing companies at low costs. This could make an funding in HireQuest at that time much more profitable.