KELYA - Kelly Services: A Turnaround Story In Its Early Innings

2023-11-23 02:34:25 ET

Summary

• Kelly Services is exiting its operations in Europe, which may aid the turnaround story of the company.
• The company has a history of poor long-term performance, with stagnant revenues and no clear margin developments.
• The sale of its European staffing business could potentially boost EBITDA margins and improve the company's financial position.

Shares of Kelly Services ( KELYA ) have recently shown some signs of life again as the company is exiting its operations in Europe. Some imagination is badly needed, as Kelly quite frankly has a very poor long-term track record.

The recruitment firm claims that it invented the staffing industry post the Second World War, connecting nearly half a million people with work every year. Shares of the company traded in their thirties already late in the late 1980s and all the way through 2007, as stagnation kicked in ever since.

By now, the company has recognized the severity of the situation and is embarking on a turnaround story after ignoring its underperformance for way too long. A transformation could unveil substantial upside, which is far from a given here, yet this remains an interesting story to watch unfold.

A Lost Decade, Or Even Longer

Still a $30 stock ahead of the financial depression in 2008 and 2009, shares of Kelly Services have largely traded around the $20 mark (just above, or below those numbers) except for a brief period of time during which shares traded in their $30s in 2018.

The reason for that is quite easy. A $5.4 billion business in 2013 has seen revenues come in around those levels pre-pandemic, but in fact, revenues have fallen below the $5 billion mark here. This has gone hand in hand with no clear margin developments and a flattish share count, making it easy to understand why shares have come down to a current price of $20 and change, and explains the long-term underperformance of the business.

The Baseline Performance

In February of this year, Kelly Services reported its 2022 results, with reported sales up a little over a percent to $4.97 billion. GAAP operating profits came in at just $15 million, but this comes after a $41 million impairment charge and a $19 million loss on disposals. GAAP net losses were reported at $62 million, equal to $1.64 per share. Adjusted for some items discussed above and a loss on an investment, adjusted earnings were reported at $1.33 per share.

The company operated with quite a clean balance sheet, showing a net cash position of $153 million, which, based on a share tally of 38 million shares, actually worked down to cash holdings of just over $4 per share. The 38 million shares traded at $18 in the early spring, granting the business a $684 million equity valuation, or just over half a billion operating asset valuation.

2023 - Modest Improvements

In May, Kelly posted a 2% fall in first quarter sales to $1.27 billion, with adjusted earnings falling by four pennies to $0.40 per share. The company furthermore initiated a comprehensive transformation program designed to significantly improve EBITDA margins.

In July, the company provided more color on the actual transformation program, including actions to monetize non-core assets, reinvest capital into both organic and inorganic growth initiatives, and focus on higher margin activities. In August, Kelly posted a 4% fall in second quarter sales with revenues down to $1.22 billion, as adjusted earnings fell by nine cents to $0.36 per share.

The bigger news arrived early in November when the company reported that it had reached a deal to sell its European staffing business to Gi Group Holdings S.P.A. The deal is valued up to EUR 130 million, with an EUR 100 million consideration due upon closing and the remainder to be potentially paid out in the form of an earn-out. Few details on the impact were announced, other than that the deal should aid the business in achieving 3.3-3.5% EBITDA margins.

A week later, the company reported third quarter results with sales down another 4% to $1.12 billion, and adjusted earnings of $0.50 per share doubling compared to the year before.

The Impact

As of the third quarter, the company ended with $117 million in cash and equivalents and no debt, as pro forma net cash will jump to about $230 million upon the initial tranche of the European operations being divested, with earn-outs having the potential to boost this number to $260 million. A share tally of 36 million shares now grants the business a three-quarter of a billion valuation, or the business at about half a billion, for a roughly 0.1 times sales multiple (ahead of the divestment), and just above that multiple if we account for the divestment.

The European operations generated $215 million in sales in the third quarter, with revenues reported at $645 million so far this year. Trending at roughly $860 million per annum, Kelly Services fetched just over a 0.1 times sales multiple; in fact, about 0.16 times if we factor in the earn-out provision. Unfortunately, the company does not provide details on the margins between each of its segments, at least not on an operating profit basis.

And Now?

The new Kelly Services posts revenues of around $4.4 billion ahead of the divestment in Europe, with pro forma sales really seen closer to $3.5 billion after accounting for the divestment. The goal is that these businesses will post EBITDA margins in the low 3%, something which could drive EBITDA over a hundred and twenty million. If the business can grow margins by a point, that has huge implications as every point improvement in sales could boost pre-tax margins by a dollar per share, while adjusted earnings trend at $1.75 per share already.

This suggests that earnings could realistically run at $2.00-$2.50 per share, and this includes about $6 per share in net cash. This means that the unleveraged business would trade at just 6-8 times earnings. That is a bit too simplistic as it requires flawless execution on the anticipated margin expansion but moreover assumes that no huge restructuring charges are to be incurred anymore, which is not realistic here.

Given all this, there are some positives in this long-term underperformance story. Of course, the company has woken up and realized its long-term underperformance, as the move in Europe seems value-accretive. Moreover, the business is modestly profitable and has a strong balance sheet, meaning that leverage issues are not a concern here as well.

This leaves just the belief in the turnaround story with real margin expansion envisioned and over time topline growth as well, both of which are still hard to find here and require real belief in the turnaround. Amidst all this, I am taking a wait-and-see approach, keeping a close eye on the developments from here before considering my neutral stance.

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