A stock to lock away — for the moment
It’s unusual for a company, even for one of the oft-overlooked small-cap variety, to trade at a trailing earnings multiple of less than five times after notching up four consecutive years of bottom-line growth.
Workforce, a specialist services company with a sizeable human temporary staffing ele- ment, “enjoys” such a desultory market rating.
Of course, a stifling operating environment created by labour regulation and ongoing efforts to vilify temporary employment services do weigh on investment sentiment.
Workforce is acutely aware of this, and its investment presentation dedicates a page to outlining the positive spin-offs from its craft, most notably meaningful job creation, youth employment, a strong focus on training, equivalent benefits to permanent workers and a significant conversion of temporary to permanent workers.
In isolation, Workforce’s interim numbers hardly justify the share trundling along at a 12-month low. Revenue was up 14.5% to R1.37bn, with gross profit coming in 8% higher at R313m as the margin crimped to 23% (previously 24%) on the back of lower margins earned on newer contracts. With several niche acquisitions clinched in the past year, Workforce’s organic top-line growth rate was a reassuring 8.4%.
Bottom line was up 5% to 18.6c/share — not a shabby performance in the prevailing economic conditions.
More importantly, though, cash flow from operating activities increased markedly to R45m (from R10m) — equivalent to about 20c/share. The cash conversion ratio was a pleasing 81%, up on the 35% seen in the corresponding interim period in 2016.
Workforce traditionally enjoys a stronger second half (though infrastructure projects could introduce volatility), and this suggests revenue should top the R2.75bn mark and earnings should come in at 42c-45c/share. In other words, we might be looking at a forward earnings multiple of between 3.6 and four.
While Workforce’s operating engines seem to be purring and its acquisition strategy starting to pay off, several drawbacks are tempering market enthusiasm. One might say the company faces a Catch-22 situation: it desperately needs to improve liquidity (more than 80% of Workforce is controlled by founder and chairman Ronny Katz and empowerment company Vunani), but it is unable to
issue new shares because of its lowly market rating.
Resuming dividends, which were last issued in 2007, would probably attract some market attention, presuming the cover is not too conservative. A share buy-back would not be the worst option either. But CEO Philip Froom stresses that cash flows, for now, are best utilised for acquisitions.
Overall the market remains sceptical about Workforce, but it is inclined to give the company the benefit of the doubt. Prevailing trading conditions probably mean it can mobilise a fairly stout balance sheet for well-priced opportunities.
While it seems likely the company will carefully bolt on new offerings, obvious larger opportunities could be snared by scouting around a restructuring Adcorp, or enticing smaller rival Primeserv into a takeover/merger.
As such, Workforce is essentially a stock to lock away in the bottom drawer. Looking a few years ahead, there are challenges — most importantly the end of the employment tax incentive, which might, of course, be replaced or even extended. But by that time Workforce, which has successfully executed six acquisitions in 18 months, will be a far more diverse enterprise.
IM reckons an enlarged Workforce could earn about 55c/share by financial 2019, and have the ability to pay a dividend (assuming a cover of about 2.5 times) of 20c/share.
At current levels, the downside is limited by tangible net asset value of 132c/share, offering a solid underpin that is not usually associated with an asset-light services counter.