KFY - Korn Ferry: Integrated Strategy Supports Reversion From Heavy Discount

2023-05-11 00:41:23 ET

Summary

• In the TTM period, Korn Ferry (-22.24%) has experienced poorer price action to both the market (SPY: +3.20%) and TradingView's Industrial Index (+10.39%).
• This reflects declining YoY growth in quarterly cash flows, with Q3 2022 cash flows down 30.38% from Q3 2021.
• Rising interest rates and subsequent declines in industrial demand have spurred this downtrend.
• Nonetheless, I believe the market has overreacted to this temporary headwind and that Korn Ferry's talent centricity, diversification, and balanced capital allocation will ensure growth.
• Thus, due to combined underpricing and operational strength, I rate Korn Ferry a 'buy'.

Korn Ferry ( KFY ) is a global organizational consulting firm, that works with its clients to design optimal workforce structures, roles, and responsibilities and gain maximal per capita productivity.

Through its activities, in the past year, the consultancy has recorded revenues of $2.85bn alongside a net income of $248.21mn and free cash flow of $302.32mn.

Introduction

Korn Ferry describes a threefold current strategy focused on capturing resilient growth; the firm seeks to sustain its leadership in organizational consulting, align its suite of solutions with pre-eminent macro trends, and position itself for scalable and sustainable growth.

Breaking down the firms' revenue on a segmentation basis, Korn Ferry generated 31% of fee revenue through Executive Search, 24% through Consulting Operations (with industrial consulting a core focus), Digital solutions accounted for 13%, Professional Search & Interim 17%, and Recruitment Process Outsourcing (RPO) 15%.

Valuation & Financials

General Overview

Over the past year, Korn Ferry has trailed both the market- up 3.20%- represented by the S&P 500 ( SPY ) as well as TradingView's Industrial Index- up 10.39%, the sector from which most of Korn Ferry's demand is derived, making it the most comparable performance index.

I see this as a product of falling demand for the non-mandatory, somewhat periphery products which Korn Ferry offers, with the dual pressure of inflation and rising interest rates reducing the corporate ability to purchase Korn Ferry services.

Comparable Companies

Due to the relatively small size of the organizational consulting market, each of the firms in the arena operates in a more niche and specialized sub-sector, such as Korn Ferry and executive search. First Advantage ( FA ) and ASGN ( ASGN ) operate with a particular focus on IT and technology staffing while ManpowerGroup (MAN) applies a more mass-market approach.

As expressed above, Korn Ferry's poor price performance, both over the past quarter and year, has not been out of the ordinary amongst peers.

Other financial indicators are yet more bullish for investors and Korn Ferry alike; the company maintains the second-best revenue growth and the best earnings growth over the past 5 years, indicating a level of margin expansion.

Moreover, assessing the company on a multiples basis, the company maintains the best value- lowest- trailing P/E, P/CF, and debt/equity ratios.

Further emphasizing Korn Ferry's fiscal superiority and undervaluation is best-in-class ROE, ROA, and profitability.

Valuation

According to my discounted cash flow analysis, Korn Ferry is undervalued by 28% at its base case, with a fair value of $66.08, up from its current price of $47.36.

My DCF model assumes a benchmark discount rate- the same as WACC here- of 8%, owing to a debt-lite capital structure. Alongside this, I assume a reversion to historical net margins and net margin growth of ~2% in line with inflation. The model is calculated over 5 years without perpetuity.

AlphaSpread's multiples-based relative valuation tool nearly identically corroborates my thesis on undervaluation, estimating a fair price of $65.19, meaning that the company is currently 27% undervalued.

Thus, the actual fair value of Korn Ferry is likely between the small range of 27-28% undervalued between the prices of $65.19-$66.08.

Strong Core Objectives & Integrated Client Engagement Invite Growth

Korn Ferry's central obligations, surrounding organizational consultancy, operate with an effective level of cross-selling potential. Including executive search, direct consultancy, RPO, digital, and Professional Search and Interim, Korn Ferry lends itself as an ideal candidate for any company undergoing transformational change. If Korn Ferry is chosen as a candidate for helping an organization find a hypothetical executive, the logical conclusion is to leverage the pre-existing relationship and use Korn Ferry for other staffing needs as well.

This strategy has enabled a high degree of revenue diversity, on a vertical, geographic, and industry basis.

The strengths of said revenue diversity are best exemplified by the company's response and relative performance to the macro headwinds ultimately harming demand. While Korn Ferry's largest segment, executive search, has seen real revenue declines over consecutive quarters, the company's digital, consulting, and particularly Professional Search & Interim- owing to significant labour shortages- have seen noteworthy growth metrics.

In order to maintain a resilient and growth-centric approach, Korn Ferry applies a balanced and disciplined capital deployment strategy, involving a combination of inorganic growth, opportunistic share repurchases, returning income to shareholders, capex for organic growth, and debt servicing. This both supports a leaner and more efficient cap structure, creates shorter-term value for investors and enables long-term cash flow and margin growth.

Wall Street Consensus

Analysts sustain an even more positive attitude on the stock than I, predicting, at its base case, an average price increase to $64.25, an increase of 35.41%.

Even at minimum growth, analysts project a price increase of 24.34%, to a value of $59.00.

I believe this is highly reflective of the company's undervaluation and operational strengths going forward.

Risks & Challenges

Inability to Sustain Talent

Core to all the objectives of Korn Ferry is its group of consultants and executives, with highly specialized and niche roles and capabilities. Loss of this human capital can lead to material reductions in the firm's ability to operate effectively and generate sufficient cash flows in the mid-long term.

Increased Competitive Intensity

The barriers to entry in the staffing industry are constrained to capital factors, as those with sufficient financing can attract superior human capital. As such, Korn Ferry faces competition not only from traditional staffing firms but larger consultancies with deeper pockets as well as backwards integrating clients, creating multi-sided concerns of increased competition and reduced demand.

Continued Reductions in Demand

If interest rates continue to rise or remain as high as they are and if inflationary pressures aren't reduced, firms will be unable or unwilling to spend on the nonessential services Korn Ferry provides. Especially in the short term, this presents a risk to profitability and may lead to additional financing requirements if sustained.

Conclusion

In the short term, I expect Korn Ferry to revert to its fair value while its revenue diversification continues to yield growth.

In the long term, I project that Korn Ferry's solid capital deployment strategy alongside integrated staffing offerings will continue to enable the company's leadership.

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