Empresaria (LON:EMR) has outperformed its immediate sector peers by 99% over the last 3 years, and the FTSE All-Share by 142%. This reflects strong growth in earnings and cashflows, which we attribute to the group’s focus on high growth markets.
The company provides specialist staffing services across global markets with a focus on flexible/temporary staffing. The key differentiator versus the peer-group is a focus on high-skilled niche segments where Empresaria (LON:EMR) can establish sector leadership.
The benefit of this strategy has been particularly clear in 2016 when many of the peer group companies have suffered more difficult conditions. In this report we examine the moving parts of the business model, and we conclude that the three major sources of earnings growth are set to keep functioning in 2017e and beyond.
ORGANIC REVENUE GROWTH
We examine the growth drivers for flexible staffing in specialised applications and high growth geographies. We conclude that the company is positioned to deliver mid-high single digit organic growth in fee income in the medium term.
EXTERNAL INVESTMENTS
In 2017 we expect to see a strong earnings contribution from the full-year contribution of investments in ConSol (IT) and Rishworth (aviation). We examine some of the metrics relating to recent investments, along with a brief case study of Rishworth in particular.
IMPROVING CONVERSION RATIO
The “conversion ratio” measures the conversion of Net Fee Income into Operating Profit. This has been on an upward trend, and we forecast further increases contributing additional earnings growth in the coming years.
RESULTS / VALUATION
Today’s results confirm the trajectory which was outlined in the January trading update - double-digit EPS growth in 2016 and an outlook for accelerating growth in 2017e. We are maintaining our 2017e EPS forecast at 13.5p. The trailing P/E multiple for 2016 stands at 12.4x, and if we were to exit 2017 at the same multiple then this would imply a share price of 168p 12 months from now, an upside of 20%. We argue that all of the drivers remain intact for continued shareholder value creation.
SUMMARY
The following chart shows the performance of Empresaria (LON:EMR) versus the five closest peers by market cap and business profile: Gattaca, StaffLine, S Three, Harvey Nash, and Servoca. We have indexed the peer-group to the starting share-price of Empresaria.
The outperformance of Empresaria has been most pronounced during the last 18 months, when we believe the differentiated business model has been evident against a weaker backdrop for the generalist agency staffing sector.
The company describes its philosophy as “inch wide, mile deep”, meaning that the focus is on building the depth of expertise to be a market leader in each of its chosen niches, rather than spreading out to become a generalist.
Within this framework there are four avenues of growth:
• Expand an existing brand’s penetration in its current niche by adding headcount
• Expand an existing brand into new sectors or geographies • Grow an existing brand with a bolt-on acquisition
• Make an investment in a new market vertical or new geography
In this report we offer a detailed analysis of how Empresaria differs from the wider sector, and why we think the specialised focus has been delivering results and will continue to do so in the coming few years.
The following chart summarise the end-market exposure of Empresaria.
ORGANIC GROWTH
We first consider the organic drivers of fee income for Empresaria.
Flexible employment practises have accounted for an increasing share of the overall labour market in recent years. This includes the lower end “zero-hours” shift worker arrangements, but more relevant for Empresaria is the role of specialised professional contract workers. This model is well established in fields like IT Services, but also increasingly prevalent in a wider range of sectors including legal, accounting, medical, engineering, and aviation.
The following chart shows the growth in contractor employment versus salaried employment, for the US and the UK.
This does not tell the whole story. We believe that the growth rate remains faster in the higher skilled, higher specialised segments, compared with the general labour segments. But also geographically there are wider variances in the penetration of contractor / temporary employment practises within the overall labour market. An important factor for Empresaria in recent years has been identifying where flexible working is an emerging trend geographically as well as by sector. The following chart shows the differing levels of flexible working within various geographies.
Given the secular trends, we would expect to see Empresaria delivering strong growth organically (excluding external investments, excluding currency benefits). The following chart shows the breakdown of the company’s growth in Net Fee Income in recent years.
The company does not publish its own breakdown of growth in this way, and these calculations are based on Capital Network’s analysis.
These figures confirm that Empresaria has indeed produced strong organic revenue growth in recent years. The organic growth figures for 2014, 2015, and 2016 are 10.5%, 13.5%, and 0.5%, by our calculation. .
In 2016, a weaker organic growth environment led to a tougher year for many industry peers, but Empresaria was able to offset this via external investments. In aggregate, we believe the figures support our view that the company can achieve a trend level of mid-high single digit organic growth.
GROWTH DRIVER – EXTERNAL INVESTMENTS
We have noted that Empresaria targets four avenues of growth:
• Expand an existing brand’s penetration in its current niche by adding headcount
• Expand an existing brand into new sectors or geographies
• Grow an existing brand with a bolt-on acquisition
• Make an investment in a new market vertical or new geography
The following table summarises the recent external investments that the company has made
In the case of healthcare and IT, these are expansions within an existing vertical, whereas aviation represented an entirely new vertical.
Several features are clear within these investments:
• All are tightly focussed, high value-added niche businesses
• EV/EBIT multiples and cashflow yields meet criteria for immediate value-enhancement to Empresaria
• The philosophy of Management Equity is applied, in the case of ConSol and Rishworth via residual holdings for the existing proprietors, and in Pharmaceutical Strategies via management buying second-generation equity, in line with group strategy.
We next offer an overview of the Rishworth investment:
CASE-STUDY: RISHWORTH AVIATION
Rishworth Aviation is a pilot leasing specialist, headquartered in New Zealand, which provides experienced pilots for dozens of major airlines worldwide. The customer base has a strong exposure to Asia-Pacific, with significant exposure also to Europe and Africa. The Asia-Pacific region remains a strong growth market, as illustrated by the following chart showing passenger volume growth.
A look at Rishworth’s client base reveals that there is a big exposure to very fast growing airlines such as Lion Air, Norwegian, or China Southern. Pilot leasing offers a buffer of flexibility within the fast evolving business plans of these airlines.
But the employees nonetheless have to be pilots type-certified for a particular aircraft to FAA or equivalent standards and specifically trained to the airlines’ operating procedures.
This is a clear example of Empresaria’s focus on high value-added flexible staffing, as opposed to paid-by-the-hour temping agency work. In fact, in the case of piloting the contract terms are typical several years, rather than weeks or months.
Finally, we note that the multiple paid for the Rishworth investment was particularly attractive at 4.5x EV/EBIT by our calculation. Opportunities like this don’t arise very often, but the deal shows that a patient and disciplined approach to M&A can sometimes deliver very attractive investments.
GROWTH DRIVER – IMPROVED CONVERSION RATIO
In addition to organic revenue growth and external investments, we believe that Empresaria has continued potential to improve its Conversion Ratio. This is the ratio of Operating Profit from Net Fee Income. The following chart shows the level of improvement that Empresaria has delivered in recent years.
The improvement during 2016 was relatively modest, due to the different characteristics of the new external investments, but we believe the company will continue to push the ratio higher in the coming years, Empresaria has targeted a conversion ratio of 20% in the medium term. Taking into account all of the three major earnings drivers, we are forecasting 25% growth in EPS for 2017, with a significant contribution from the full-year contribution of ConSol and Rishworth, but also from organic revenue growth and from the continued improvement in conversion ratio. The following chart shows the relative contributions of each of these three drivers in our 2017 earnings forecast.
Conclusion:
Empresaria has delivered strong growth in earnings and cashflows, and demonstrated considerable resilience, and we attribute this to the niche-focussed and geographically diverse footprint of the business. We believe conditions remain in place for continued growth with well balanced drivers.
FINANCIAL MODEL
The following chart summarises our P&L forecasts for Empresaria.
The next tables summarise our balance sheet and cashflow forecasts
At the net debt level, we present both a “statutory” and an “adjusted” net debt figure. Since the acquisition of Rishworth Aviation, the company holds a certain amount of cash in pilot-bonds, which are repayable sums of money posted by pilots to offset their training costs. For statutory purposes Empresaria is required to treat this as the company’s own money. But for planning purposes the company takes a more prudent view and excludes this extra cash. Our adjusted net debt figure applies this more conservative standpoint.