TNET - TriNet Group: A Solid HR Play But Not The Most Attractive In The Current Environment

Summary

• TriNet Group has demonstrated a nice history of growth on both the top and bottom lines.
• Long term, the company likely will fare just well, but it is showing some signs of weakness right now.
• Though far from a bad play, there are likely better prospects in the space to be considered.

When most people think of human resources, they likely think of an in-house department of a company dedicated to hiring, firing, and other human capital-related needs. However, one thing that has become very popular amongst firms has been outsourcing these activities so that the company in question can focus on its core strengths. One company that provides this kind of work is TriNet Group ( TNET ). Over the past few years, the enterprise has done quite well to grow both its top and bottom lines. It is important to note that the 2023 fiscal year might be a bit different. More likely than not, sales will be flat, and earnings and cash flows will be down. Relative to similar players, TriNet looks to be tilted toward the cheap side. But given changing conditions, I would make the case that there are better prospects on the market to be had at this time. Because of this, I've decided to rate the business a 'hold' to reflect my view that shares should generate upside or downside that more or less matches the broader market moving forward.

A niche business

As I mentioned already, TriNet operates as a human resources firm. It does this largely for small and medium businesses that require human resources activities but that may lack the resources or the will to build an in-house team. To truly understand the company though, we should dig in to all of the different services that it offers. First and foremost, it provides human resources consulting expertise. This part of the business focuses on providing guidance to clients when it comes to human resources needs, such as talent management, retention, and termination. These services also extend to guidance related to benefits enrollment, immigration and visas, payroll tax credits, employment compliance and regulatory developments, and even industry-specific human resources issues.

Outside of this, the company also provides employee benefits and insurance programs to its clients. By sponsoring these types of programs for multiple customers, TriNet believes that it can get options and prices that would be outside of the capabilities of its customers on its own. These programs include, but are not limited to, health insurance, dental, vision, disability, and life insurance. They can even extend into things like auto insurance and pet insurance. The company also provides payroll services to its clients, including multi-state payroll processing, tax administration, tax credit services, and more. Under its risk mitigation activities, the company monitors employment-related legal and regulatory developments across all government levels in order to help clients comply with applicable employment laws. Oversight here includes things like unemployment insurance, family and medical leave, anti-discrimination policies, and more.

The business includes more than just its consulting services. It also has its own technology platform that has been split into two separate sections. One of these is for its PEO clients. It allows these clients to store, view, and manage human resource information and to administer human resources transactions like payroll processing. The technology also helps with employee onboarding and termination, employee performance, expense management, and more. The second involves its HRIS software, which allows clients under that umbrella to manage most of the same functions as the PEO clients are afforded. On top of this though, it also offers customizable and flexible reporting tools and analytics that are specific to the clients' needs. For context, HRIS customers are those where a client employee is not co-employed by TriNet, while a PEO client is one where co-employment between TriNet and the client in question exists.

Over the past five years, the management team at TriNet has done a really good job growing the company's top line. Revenue went from $3.50 billion in 2018 to $4.54 billion in 2021. In 2022, sales continued to climb hitting $4.89 billion. From 2021 to 2022, the roughly 8% sales increase the company experience was driven largely by a 5% rise in what it charges its customers. Increased volume of activity added another 2%. During this 2021 to 2022 timeframe, its professional service revenues jumped by 18%, climbing from $639 million to $754 million. This increase, according to management, was driven largely by a 7% rise associated with its HRIS cloud services revenue, largely thanks to its acquisition of Zenefits and a growth in rate from its PEO services. Increased rates that it charged under these operations added another 6% to sales, while increased volume contributed 2%. Insurance services revenue for the company, which makes up the bulk of its operations, grew a more modest 6%, with rate increases contributing to 4% of that rise and higher volume contributing 2%.

Over the same five-year window, the company's bottom line also improved nicely. Net income expanded from $192 million in 2018 to $355 million in 2022. In no single year during this timeframe did the Business Report a year-over-year decline in sales. Other profitability metrics were a bit lumpy. Operating cash flow, for instance, bounced around between negative $104 million in 2018 to positive $562 million in 2022. If we adjust for changes in working capital, however, we would have seen the metric increase year after year, climbing from $283 million to $550 million. Meanwhile, EBITDA expanded from $347 million to $688 million over the same window of time.

This is not to say that everything has been great for the firm. Toward the end of its 2022 fiscal year, it did show some weakness on both its top and bottom lines. Revenue in the final quarter of the year came in at $1.23 billion. If we round, we get the same number one year earlier. But in all actuality, sales dropped by $6 million. Higher costs resulted in profits falling quite a bit. Net income, for instance, dropped from $67 million to $49 million. It is true that operating cash flow jumped, rising from $234 million to $486 million. But if we adjust for changes in working capital, it would have fallen from $95 million to $85 million. And over that same window of time, EBITDA for the business shrank from $116 million to $111 million.

For the 2023 fiscal year in its entirety, management said that revenue will range between shrinking 2% and growing 2%, with professional services revenue rising by between 1% and 5%. The firm's earnings per share guidance is a bit tricky. They said that profits should be between $3.30 and $4.08. On an adjusted basis, they should be substantially higher at between $4.85 and $5.65. But much of this disparity is driven by things like stock-based compensation, amortization, and more. In short, the adjusted earnings are supposed to reflect something closer to cash flow. I would stick with the GAAP earnings in this case, which imply, at the midpoint, net income of $236.2 million. If we assume that the same decline hits other profitability metrics, then we would get adjusted operating cash flow of $365.9 million and EBITDA of $457.8 million.

As you can see in the chart above, shares of the company do look pricier if we use the estimates for the 2023 fiscal year. The 2022 fiscal year, likely benefiting from a strong labor market perfect, is the most attractive of the three fiscal years shown. As part of my analysis, I also compared the company to five similar firms. I do believe that we should focus more on the forward earnings and cash flows when evaluating the company. But because the numbers shown in the table below are on a trailing 12-month basis, it would only be appropriate to compare them all utilizing data from 2022. On a price-to-earnings basis, these companies ranged from a low of 9.5 to a high of 59.9. Two of the five companies in this case were cheaper than TriNet. Using the price to operating cash flow approach, the range would be from 6.8 to 15.4, while the EV to EBITDA approach results in a range of between 5.2 and 14.5. In each of these cases, only one of the five firms was cheaper than our prospect.

Takeaway

Fundamentally speaking, TriNet has had a great run and I fully suspect that trend will continue in the long term. With that in mind, management seems cautious when it comes to the near-term outlook, particularly the 2023 fiscal year. Although sales might increase, it's more likely than not that its bottom line results will worsen throughout the year. And this assumes that the company does not buy back any stock, in which case the earnings per share would result in even lower profits then I calculated above. Truth be told, I don't think that TriNet is a horrible company at all. In fact, I think it's a great business for those with a very long-term mindset. But for those looking to beat the market, I do think there are better prospects to be had. And as such, I've decided to rate the business a 'hold' at this time.

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