HRT - HireRight Holdings: Not The Right Stock Yet (Rating Downgrade)

2023-07-14 16:36:18 ET

Summary

• HireRight Holdings Corporation has seen a violent standstill and actual reversal of sales growth in recent times.
• This hurts the margin profile of the business, and limits the deleveraging power of the business.
• Amidst some concerns, the overall cheapness looks to be sufficient of a reason to get more upbeat here.

In October of last year, I believed that HireRight Holdings Corporation ( HRT ) was making the right moves, as the business had seen a successful year after its public offering. With shares lagging compared to the fundamental and operating performance, the compressing valuation multiples started to create a compelling situation.

That was a bit too preliminary, though, as the growth trajectory violently came to a standstill last year, although it has appeared to stabilize here, creating a stable but lower level at which shares currently trade, which frankly starts to look rather upbeat here.

Hiring The Right People For the Right Opportunity

The header of this paragraph is essentially the mission of HireRight, which offers employment screening solutions to hire the right people for the right opportunity. The global technology platform performed some 80 million screens in 2020 on behalf of 40,000 customers which used for job screening applicants, as well as current employees and contractors.

Besides hiring and related services, adjacent services are offered such as KYC checks, safety and security, as well as compliance. Founded in the 1990s, the company saw a big boost following the deal to acquire General Information Systems in 2018.

The company went public at $19 per share in the fall of 2021, with 79 million shares commanding a $1.5 billion equity valuation, although this number excluded about $600 million in pro forma net debt.

This was applied to a business which generated $647 million in sales in 2019 on which a $40 million operating profit was reported, in part held back by amortization charges related to the GIS deal. Revenues fell 17% to $540 million in 2020 (for obvious reasons) with GAAP operating losses reported at $12 million (again after large amortization charges).

The company saw a strong recovery in the first half of 2021, and with preliminary third quarter results (ahead of the IPO) suggesting a realistic run rate of $800 million in revenues and realistic net earnings of $120 million, the resulting $1.50 per share earnings power started to look compelling as share fell to $17 per share on the first day of trading.

A year later, shares were stuck around $15 per share as the company grew 2021 sales to $730 million with GAAP profits posted at $57 million. With the hiring boom ending, the company guided for 2022 sales at $805-820 million, with earnings seen at $1.32-$1.45 per share. The company hiked the sales guidance to $825 million during the year and upped realistic earnings to $1.50 per share, all while net debt fell to $575 million.

The combination of leverage coming in below 3 times and shares trading at 10 times earnings made me quite upbeat, although I have not held a position ever since.

What Now?

Since October 2022, shares have fallen from $15 to $11 per share, marking a huge decline. In fact, shares plunged to just $8 in November of last year as the company posted a mere 3% increase in third quarter sales to $210 million. Moreover, the company cut the full year sales guidance from a midpoint of $825 million to $801 million, with cuts made to the EBITDA guidance as well. In response, management authorized a $100 million buyback program in the wake of the pullback seen in the shares.

In March, HireRight posted a near 12% fall in fourth quarter sales to $175 million, although GAAP operating earnings more than doubled to $16 million amidst amortization charges coming down. With full year revenues coming in near $807 million, this number came in ahead of the downbeat guidance, all while net debt ticked down to $529 million, with full year EBITDA reported at $188 million.

The outlook for 2023 was quite downbeat with sales seen at $720-$745 million, EBITDA at around $170 million and earnings between $1.30 and $1.43 per share. This suggests flattish performance from the fourth quarter annualized numbers, and thus no growth. While the company cites macro concerns, the reality is that the results are softer and this might be due to labor market dynamics, although many macro trends make it figure out if this revenue decline is self-inflicted (and the company is losing market share) or whether this is entirely a macro trend.

In May, HireRight posted first quarter sales of $175 million, flat from the fourth quarter and down another 12% on the year as well. While margins were strong in the fourth quarter, GAAP operating losses were reported at a million. This resulted in a GAAP loss of $0.10 per share and an adjusted profit of $0.18 per share, although this excludes some items like a five cents per share stock-based compensation charge, and some other smaller chargers. Net debt ticked up to $562 million, due to some initial buybacks, all while the outlook for the year as mentioned (on all fronts) was maintained.

In June, the company announced another $25 million buyback program after two smaller bolt-on deals were announced in the first half of the year.

A Final Take

Given the HireRight Holdings Corporation trends above, that of a violent shock to the earnings growth trajectory, I find myself performing a balancing act. Net debt has come down, but with EBITDA under pressure and some buybacks executed upon, leverage ratios are not coming down anymore from about 3 times here.

In the meantime, the business is trading quite stagnant and while the adjusted earnings multiple comes in at just around 8 times, the realistic multiples are coming in the lower teens (if we adjust for stock-based compensation, for instance).

Hence, I continue to be upbeat about HireRight Holdings Corporation given the valuation, but I am quite frankly a bit shocked by the operational weakness, which was substantial I must say. That being said, it is the lower valuation which makes me happy to consider a small position (albeit somewhat speculative) in HireRight Holdings Corporation shares in hopes for better times and a partial re-rating of this stock.

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