A stock to lock away — for the mo­ment

Financial Mail - Investors Monthly - - Analysis - Marc Hasenfuss

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.

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