KELYB - Kelly Services: A Bet On Education Undervalued

Summary

• Kelly Services connects companies with workers and facilitates the selection process.
• I am quite optimistic about the future of Helix UX, which offers talent selection across different cloud-based talent pools.
• Further investments in the Education business segment could lead to future CFO generation.

Workforce management solutions provider Kelly Services, Inc. ( KELYA ) recently signed several acquisitions, which are making the company's Education business segment grow significantly. Besides, the company appears to be looking at new inorganic opportunities. I also believe that further development of Helix UX and new tools to recruit from cloud-based talent pools could bring significant revenue expectations. I obviously see risks from changing regulatory frameworks and labor laws in the United States and abroad, diminishing demand for temporary jobs, or risks from competitors. With that, my models indicate that the fair price could be closer to $30 per share, which is larger than the current market price.

I Am Optimistic About Kelly's Investments In Education, Further Development Of Helix UX, And Successful Acquisitions

Since 1946, Kelly Services has been active as a job agency, in other words a company designed to connect companies with workers and facilitates the selection process. Based in the United States and offering its services in Europe, North America, and Asia, Kelly connects around 350,000 temporary employees per year.

The company reports five segments within the company: professional and industrial, science, engineering and technology, education, outsourcing and consulting, and international.

In 2022, the most interesting business segment in terms of sales growth was Education, which delivered close to 50% sales growth in the third quarter . I believe that further investments in this business segment may offset potential revenue declines in the other business units.

In line with the previous rationale about the growth in the Education business segment, let's note the acquisition of PTS, which is expected to bring new products related to behavioral health therapies.

And in May 2022, we completed the acquisition of PTS, a specialty firm that expands our K-12 leadership position and provides in-school services for occupational, physical, speech and behavioral health therapies. Source: 10-Q

I believe that we could see new acquisitions in the coming years considering that management continues to look for inorganic opportunities.

We will continue to look for opportunities to grow both organically and inorganically in 2022 and beyond. Source: 10-Q

In recent years, due to the change in the global trend in the markets, in terms of both job demand and consumer demand, the company had to adapt its way of providing services to the new digital environment that governs the job market. In line with this strategy, I am quite optimistic about the future of Helix UX, which was launched in 2021, and offers talent selection across different cloud-based talent pools.

We are mapping our digital transformation journey, building a technology foundation to optimize our business, personalize the talent journey and improve the client experience. In 2021 we launched Helix UX, an industry-leading talent management tool that is enabling our customers to better manage their global workforce across temporary, full-time and cloud-based talent pools. Source: 10-Q

Balance Sheet

In the last quarterly report, Kelly reported $122 million in cash, trade accounts receivable of $1.519 billion, and total current assets worth $1.73 billion, close to 1.7x the total amount of current liabilities. Non-current assets include net property and equipment worth $24 million, deferred taxes of $300 million, and goodwill of $161 million. With an asset/liability ratio around 2x, in my view, the balance sheet appears in good shape.

With accounts payable worth $735 million and accrued payroll worth $321 million, current liabilities stand at $1.14 billion. The company does not seem to have meaningful debt. However, Kelly does report accrued retirement benefits worth $172 million, which I included in the calculation of the enterprise value.

DCF Model Using Sales Growth Of 7%

If we assume further investments in new tools to recruit from cloud-based talent pools and further investments in the Education business segment, I believe that we can be optimistic about future CFO generation.

I took a look at the expectations of market experts to assess future sales growth. The global temporary labor market size is expected to grow at close to 6.4% CAGR from 2019 to 2025. Besides, the workforce management market size could grow at close to 10.2% CAGR from 2020 to 2027. Considering these estimates, I assumed that sales growth of 7% for Kelly Services could make sense.

The global temporary labor market size was valued at USD 436.42 billion in 2018. It is anticipated to register a CAGR of 6.4% from 2019 to 2025. Source: Temporary Labor Market Size, Share | Industry Trend Report, 2019-2025

The workforce management market size was valued at $4,350 million in 2019, and is projected to reach $9,391 million by 2027, growing at a CAGR of 10.2% from 2020 to 2027. Source: Workforce Management Market Size | Industry Share - 2027

My results include 2028 revenue of $7.884 billion and sales growth of 7%. The cost of revenue would be close to $6.40 billion, which would imply a gross profit of $1.47 billion and operating income of $89 million.

The modeling of the cash flow statement would include 2029 net earnings of $59 million, deferred income taxes of $37 million, and D&A of $51 million. Amortization of operating lease assets would stand at $36 million with 2029 stock based compensation of $9 million. Besides, with changes in operating assets and liabilities of -$18 million, 2029 cash flow from operations would be $146 million. Let's note that the cash flow from operations would range from $97 million to $146 million from 2023 to 2029.

2029 CFO would likely be $136 million, along with a capex of -$18 million and a FCF close to $119 million, resulting in a NPV of $515 million.

The company currently trades at 8.3x EBIT, and other companies operating in the same industry trade at a median of 17x TTM EBIT. I assumed 2029 EV/EBIT multiple of 14x, which I believe is sufficiently conservative.

I obtained a net present value of $678 million. If we add $122 million in cash, and subtract retirement benefits of $172 million, the resulting equity would stand at $1.142 billion. Finally, the implied price would be $30.1 per share.

Competitors Are Massive Corporations

The market in which Kelly Services operates is not only highly competitive but also highly fragmented. Both locally and internationally, the largest registered competitors during 2021 were Adecco Group ( OTCPK:AHEXF ), Randstad ( OTCPK:RANJF ), ManpowerGroup ( MAN ), Recruit Holdings ( OTCPK:RCRRF ), and Allegis Group. In sum, Kelly competes with companies with greater infrastructure at an international level.

Risks From New Entrants Or Diminishing Demand For Temporary Workers

Among the risks that the company lives with, we can mention the easy accessibility of its business to the market, which permanently generates new companies competing for the same clients. Although Kelly has a client base made up of large corporations, these are not backed by contracts or long-term business commitments, which could lead to a sudden disengagement and shutdown of a large part of its operations.

In addition, Kelly Services must have a correct reading in order to provide useful and quality services to its clients, including the growth of technologies. Failed understanding of new job markets from 2023 could bring revenue expectations down.

Besides, if the level of economic activity and employment in the United States deteriorates, large employers may hire less temporary workers, which would lead to diminishing revenue for Kelly Services. In a recent annual report, the company disclosed how lower economic activity could impact Kelly's financial figures.

When economic activity increases, temporary employees are often added before full-time employees are hired. As economic activity slows, however, many companies reduce their use of temporary employees before laying off full-time employees. Customer responses to real or perceived economic conditions, including perceptions related to market conditions, labor supply and inflation, could negatively impact customer behavior. Source: 10-k

Government agencies under the U.S., new foreign competition laws, or labor laws could also harm Kelly's business model. Let's keep in mind that Kelly Services may be studied by governments in the United States, Europe, and Asia.

As a leading staffing and recruiting company, we are closely scrutinized by government agencies under U.S. and foreign competition laws. An increasing number of governments are regulating competition law activities, leading to increased scrutiny. Some jurisdictions also allow competitors or consumers to assert claims of anti-competitive conduct. Source: 10-k

Takeaway

Kelly's investments in education, further development of Helix UX, and the promised inorganic growth could bring further revenue growth and free cash flow generation. Considering the current state of the balance sheet, obtaining new debt for new investments could be likely. I also see risks from lower demand for temporary jobs, changing labor laws, foreign competition laws, new entrants, or large competitors. With that, I believe that the company is significantly undervalued as compared to peers, and future FCF could imply a valuation close to $30 per share.

For further details see: