2023-06-21 15:08:45 ET
Summary
- TriNet Group, Inc. is a $5.8 billion market cap firm that offers comprehensive human capital management solutions to small and medium-sized businesses.
- Rising ICR and falling WSEs negatively impacted the company's bottom line profitability in Q1 FY23.
- Despite headwinds, TNET saw gains in customer retention and new sales, with a 3-point YoY improvement in retention and a 20% increase in new sales.
- Once the US unemployment rate rises, TNET could see a significant sell-off, and no share buyback program will save it in that case, in my view.
- Given TNET's already generous valuation, I'd like to rate TNET as Neutral. But in the absence of such an opportunity, I rate the stock as Hold.
The Company
TriNet Group, Inc. ( TNET ) is a $5.8-billion market cap firm that offers comprehensive human capital management ((HCM)) solutions to small and medium-sized businesses. According to the latest 10-Q , they operate under 2 models: a co-employment model and an administrative services-only model. Their services include payroll processing, tax administration, employee benefits programs, workers' compensation insurance, HR compliance, and other HR-related services. Under the co-employment model, TriNet becomes the employer of record for specific administrative purposes, while clients handle day-to-day job responsibilities. Through their HCM services model, they provide cloud-based HCM services for managing employee information, payroll, benefits, etc. They operate in a single segment and generate almost all of their revenue from clients in the U.S.
As far as recent financial performance is concerned, the picture is rather contradictory.
On the one hand, total sales growth of only 2% YoY in Q1 FY2023, against the backdrop of an 18% increase in operating costs, could not stop EBIT and net profit from declining by 17% and 10% year-on-year, respectively.
The Insurance Cost Ratio (ICR), which represents the ratio of insurance costs to the related insurance revenues generated by TriNet's employee benefits programs, including health insurance and workers' compensation insurance, increased by 200 basis points compared to the first quarter of the previous fiscal year. This rise in the ICR negatively impacted the company's bottom-line profitability.
Furthermore, the Average WSEs, which indicates the average number of worksite employees managed by TriNet on behalf of its clients, declined by 5% YoY. During the latest earnings call , the CFO explained that customer net hiring experienced a modest decline, with variations observed across different industry verticals and business sizes. Smaller businesses continued to hire, while larger SMBs displayed more caution due to economic uncertainties.
TNET's debt level went up by 59% YoY as TriNet took precautionary measures amidst the uncertainty caused by the banking crisis following Silicon Valley Bank's failure. They drew down $495 million from their 2021 Revolver to ensure excess liquidity. As market liquidity concerns subsided, they repaid $200 million in March, leaving $295 million of borrowings outstanding.
At the same time, however, current assets increased by $303 million, primarily due to positive changes in working capital.
On the other hand, there are also positive aspects. First off, they repaid the remaining outstanding debt balance in April 2023, so the data above is a bit outdated (we have no newer data to see the impact).
In FY2023 Q1, the company bypassed its own EPS guidance, with GAAP net income per share of $2.17 and adjusted net income per share of $2.49. TNET also saw gains in customer retention and new sales, with a 3-point YoY improvement in retention and a 20% increase in new sales.
During the call, the CEO discussed the company's initiatives, such as the introduction of new products like Clarus R+D, which helps customers capture tax credits. TriNet aims to expand the reach of these products, particularly in verticals such as technology and life sciences, expressing satisfaction with customer retention in Q1 and anticipating continued improvement throughout 2023.
The PEO (Professional Employer Organization) bookings growth showed stability throughout the quarter, and TriNet plans to add sales force headcount and increase the total rep count by the end of 2023.
The revenue contribution from Zenefits (the acquisitions closed in February 2022) was approximately $12 million in the first quarter, with an expectation of approximately $50 million for the full year. Zenefits was acquired for a total purchase price of $209 million - a small fraction of the market value the company had just a few years ago (was once valued at $4.5 billion, according to Forbes ).
I think it is Zenefits that will provide the main growth for TriNet in the coming years, actively expanding on the huge TAM:
Looking ahead, TriNet's management revised its full-year guidance, accounting for lower customer hiring but anticipating strong new sales and improved retention. They expect flat to 1% growth in Q2 revenues and raised their full-year earnings guidance:
The amount of projected growth looks quite modest. But maybe the company's valuation is not too high either and investors have the opportunity to see growth in TNET stock?
Valuation
I will be looking at several metrics other than valuation to try to determine an upside potential for the next few years.
The first thing that catches the eye is the relative resilience of the stock price over the last months. While other stocks are 20-50% off their highs, TNET stock is barely 10% off its peak:
As far as I can see, TNET has the best TTM EBITDA margin among all other peers , while its EV/EBITDA multiple for the next year is somewhere in the middle of the sample:
In the context of historical comparison, the current EV/EBITDA valuation is somewhere in the middle of the range - the company is fairly valued according to this particular valuation method, in my opinion:
However, I cannot get past the rather pessimistic revenue-related metrics for TNET stock comparison, where we see a significant overvaluation of the company:
In addition, consensus forecasts are that EPS growth next year will be relatively low (at about +1%). At the same time, you can find faster-growing companies with much lower implied multiples among the other peers:
FY2024 EPS YoY, % | P/E (FY2024) | |
TNET | 1.05% | 15.84 |
AHEXY | 16.57% | 8.15 |
ALIT | 18.01% | 11.84 |
NSP | 7.08% | 18.66 |
PYCR | 19.69% | 54.75 |
RHI | 15.67% | 13.65 |
The Bottom Line
Frankly, I like the company's performance and the strategic acquisitions it has completed in the recent past. Maybe the analysts are wrong and TNET will show much faster EPS growth rates in the next few years.
However, 2 things worry me.
First , the industry in which the company operates is quite cyclical. So far, the U.S. labor market has been very strong, but the Fed is obviously doing everything it can to weaken it - that's the fundamental result of hawkish policies. Once the US unemployment rate rises, TNET could see a significant sell-off, and no share buyback program will save it in that case.
Second , using the previous long recession ((GFC)) as an example, we saw the company's peers' profitability metrics shrink and multiples kept falling off a cliff before jumping up due to a sharp decline in the absolute values of margins. Given TNET's already generous valuation, I would not be surprised if we might see the same thing happen.
So given these risks, I would like to rate TNET Neutral, but in the absence of such an opportunity, I rate the stock Hold.
Thank you for reading!
For further details see:
TriNet Group: Good Firm Trading With A Premium