HQI - HireQuest: A Good Option In An Economic Recovery But A Hold Now

2023-11-08 02:57:42 ET

Summary

• HireQuest provides temporary employees to other companies, benefiting from the increasing number of men in the US not formally working.
• HQI's franchise model allows for higher margins and decentralized operations, reducing the need for full-time staff.
• Although the future looks promising, the current macroeconomic situation and valuation make me opt for a 'hold' rating.

Investment Thesis

HireQuest ( HQI ) operates in a sector with a business model that sets it apart from competitors and benefits from a promising long-term trend. It is also a founder-led company where the CEO owns 40% of the shares, which is always nice to find in any stock. However, due to the sector's sensitivity to economic cycles and current valuation, a ' hold ' rating is appropriate for now.

It's worth keeping an eye on the company, particularly as it can perform well during periods of macroeconomic recovery. So in this article, we will explore the company's business model, the underlying trend, and provide a valuation to have an idea of the potential returns at the current price.

Business Overview

HireQuest specializes in providing workforce solutions, offering services such as temporary staffing , on-demand labor, and various employment-related services. With a network of branch offices spanning the United States, the company serves a diverse array of industries. These services prove invaluable for businesses facing fluctuating or heightened demand, allowing them to meet short-term staffing requirements. Additionally, hiring temporary workers can be a cost-effective approach, as it doesn't necessitate the same benefits and commitments (e.g., healthcare and retirement plans) associated with permanent employees.

HireQuest operates with over 400 Franchised and Licensed Offices in the United States and an additional 18 International offices across Asia, Europe, Canada, and South America.

Moreover, the company sees an extensive addressable market worth more than $150 billion, which encompasses a variety of verticals including construction, hospitality, landscaping, janitorial, manufacturing, office workers, healthcare, accounting & finance, legal, engineering, and medical.

Shortage of Labor Force

The importance of HireQuest's services is further accentuated by a notable trend in the United States . An increasing number of men aged 25 to 54 , typically considered the prime-age workforce, are opting for non-traditional employment arrangements. The transformation of the economy has led to a surge in freelance, part-time, contract, and on-demand work, which many individuals prefer for the flexibility and autonomy it offers compared to traditional full-time employment.

Moreover, the escalating costs of living, spanning housing, healthcare, education, and essential expenses, can create financial challenges for young adults . Many choose to live with their parents as a cost-effective way to save money and alleviate financial burdens, making it easier for them to delay full-time employment.

All of these factors collectively contribute to a labor supply shortage . Consequently, companies like HireQuest become increasingly vital for their clients, enabling them to identify the right personnel and bridge the gap between growing demand and the shrinking labor supply.

The Quality of a Franchise Business Model

The franchise model employed by HireQuest sets it apart in the temporary staffing industry. By embracing this model, HireQuest delivers administrative support to its franchisees, which includes dedicated software, access to working capital, and other essential resources. In return for these services, the company collects a royalty fee based on total sales, typically averaging around 6.5%. These royalties would be HireQuest's revenues and because they do not require fixed expenses to obtain them, the company manages to have Gross margins of 100% and EBITDA margins of almost 50%.

One notable advantage of this model is that franchisees maintain their independence when it comes to the daily operations of their locations. However, they also gain the benefits of accessing HireQuest's capital, creating a symbiotic relationship that bolsters their capacity to serve clients efficiently and grow their businesses. In contrast, many of HireQuest's competitors follow a company-owned office model. In this approach, the daily management of customer interactions is overseen by individuals who may not have the same level of incentive to excel as franchisees who have a direct ownership stake in their businesses. To counteract the reduced motivation in this model, companies often have to make substantial investments in salaries and compensations to encourage employees to perform at their best. The franchise model, as used by HireQuest, can create a more aligned and motivated workforce , as franchisees are directly invested in the success of their locations and, by extension, the overall brand.

When we compare the company's numbers to those of its competitors, the difference in quality becomes even more evident, justifying the higher-than-average multiples. Without the franchise model, the company would likely have margins at least 4 to 5 times lower than its current ones. Moreover, it would be more challenging to maintain these margins in complex environments, as the fixed expenses of personnel, offices, and other operational costs would directly burden the company. This is in contrast to the franchise model where franchisees shoulder these costs.

Key Ratios

The company has shown impressive revenue growth , with annual rates of 22% since 2018 and 12% in the last twelve months. However, it is important to note that despite these strong top-line growth figures, the average margins for EBITDA and Free Cash Flow have remained at around 47% and 40%, respectively. The unpredictability in these margins over time can make it challenging to assess the long-term prospects of the business accurately.

As the company continues to expand and gain scale, it is possible that more stable and predictable margins will emerge. For investors, achieving a better understanding of the company's long-term profitability potential will be crucial, and this could become clearer as HireQuest grows and matures in the market.

The company's high Return on Capital Employed ROCE and strong Free Cash Flow ratios are indicators of its high-quality operations. The franchise model employed by HireQuest has likely played a significant role in maintaining these ratios, as it allows for higher margins and profitability compared to traditional business models. Additionally, the company's ability to make acquisitions effectively, as reflected in its ROCE, suggests that it has a successful strategy for expanding its footprint and maximizing returns on invested capital.

These metrics are vital for assessing the efficiency and quality of the company's operations, especially given the importance of acquisitions in its growth strategy. On average, both metrics are usually around 25% and it will be important that they remain at high levels, as it will be an indicator that it continues to maintain a good competitive position .

HireQuest's minimal capital expenditures relative to its cash generation demonstrate the company's efficient and flexible business model. With such low capital requirements to maintain operations, the company has the flexibility to allocate its cash primarily to growth capital expenditures, which is essential for expanding and scaling its franchise model effectively. This flexibility positions the company well to navigate various economic environments, as it doesn't have significant fixed capital commitments that could strain its financials in more challenging times.

The ability to maintain low capital expenditures is a valuable characteristic that underscores the resilience and adaptability of HireQuest's business model. It allows the company to allocate resources strategically and capitalize on growth opportunities, while also being better prepared for economic uncertainties.

Valuation

My approach to valuation involves projecting the two key performance indicators (KPIs) that contribute to sales in the future: the increase in franchises (referred to as Franchised Offices by HireQuest) and the revenues generated by the royalties from each franchise (which I will refer to as Revenue per Franchise ).

In the past, franchise numbers have increased at rates of 45%, primarily due to acquisitions, especially during FY2022. However, a concerning trend is that Franchise Revenue has decreased almost every year at an annual average of 13%. This trend is unfavorable to us because it implies that the company relies heavily on acquiring other franchises for its growth.

I estimate that the company will reduce the number of acquired franchises for several reasons, including the challenging environment with high interest rates and the recent acquisitions the company has made. It is common to slow down acquisition activity for at least one or two years after a period of numerous deals, although management has indicated that the market offers many M&A opportunities.

I anticipate that this pause in acquisitions will allow the company to focus on enhancing the profitability of existing franchises. As a result, the Revenue per Franchise is expected to increase by 5% annually.

This projection would lead to an annual revenue growth of 15% . Assuming EBITDA margins of 55% for FY2027 and applying an exit multiple of 15x EV/EBITDA, the estimated share price for that year would be approximately $50-55 USD, representing an annualized return of 10% , in addition to the annual dividend yield of 1.5%.

Final Thoughts

HireQuest has a superior business model compared to its competitors, providing it with a level of resilience during economic downturns. However, it's important to remember that the employment industry is often one of the first to be impacted during a recession. Furthermore, while the company might not be able to predict economic trends with certainty, because unemployment is a lagging indicator , there is a long-term trend that is likely to be favorable for the company in the future.

Currently, the valuation does not appear to be a significant bargain, but it still offers an attractive return of 11% when considering dividends. Taking all of these factors together, a ' hold ' rating seems appropriate.

For further details see: