By Vishnu Lekraj
While by no means robust, job growth did return to positive territory during the latter half of 2010. This dynamic continued into the first four months of 2011 with the government reporting 1.7 million nonfarm jobs added between January 2010 and May 2011. The private sector was even more robust as 2.0 million nonfarm jobs were added during this period, excluding the government sector. The unemployment rate has fallen 70 basis points to 9.1% from November 2010 to May 2011, which is a mostly positive sign as the participation rate has not fallen on par. Additionally, most employment services firms continued to report robust results during the most recent earnings season, and many management teams have stated that these trends will accelerate for the remainder of 2011. The confluence of positive data has reinforced our expectation for moderate job growth for 2011.
Given the strengthening employment market, there has been a run-up in the share prices of most employment services firms. The average price/fair value ratio for staffing and payroll processing firms is currently at 1. Many investors already have priced in a solid recovery for many of these players, in our opinion. However, there are a few names we currently believe are undervalued and offer market participants a compelling opportunity.
AMN Healthcare and Cross Country Healthcare
Why Undervalued: During the last few years, lower patient admission rates at medical facilities, light staffing turnover for clients, and uncertainty related to the future composition of the health-care industry have provided unprecedented headwinds for health-care staffing firms. This dynamic has challenged AMN Healthcare (AHS) and Cross Country Healthcare (CCRN), with each reporting revenue decreases of close to 40% and deep operating margin compression from 2008-10. Accordingly, the price of each firm's stock has tumbled approximately 50% since the beginning of the most recent recession.
Catalysts for Stock Price Appreciation: Currently AMN trades at 20 times and Cross Country trades at 25 times 2012 earnings per share consensus estimates. However, both trade at a very attractive 7.4 times and 8.7 times, respectively, to 2007 EPS results, which we believe represents a more normalized year. Coupling this valuation with growing demand for health-care services paints a very compelling long-term picture, in our opinion. We don't believe the stock price for these staffing players will continue to trade at a discount to normalized earnings given the growth opportunities within their end market. Demographic shifts and medical advances should have an aging effect upon the U.S. population, and shortages among health-care workers are anticipated. According to the Department of Health and Human Services, the current shortage of nurses will become severe by 2020.
We believe the falloff in industry results is completely due to cyclical factors, and therefore we forecast a return to a normalized level of earnings within the next few years. Even though staffing is a very tough industry, AMN's and Cross Country's niche staffing expertise within one of the fastest-growing sectors of the U.S. economy makes each firm’s current equity valuation unjustified.
Resources Global Professionals
Why Undervalued: Business project spending has bounced back in the last nine months, enabling Resources Global (RECN) to produce revenue growth of approximately 10% during this same period. Despite this strong growth, Resources Global had to contend with pricing pressure in the recent fiscal third quarter, and gross margins decreased 158 basis points to 37.01% from 38.59% a year prior. Management said a material portion of this decline was due to a compression in the bill/pay spread (the amount Resources bills its customers less the amount it pays its temporary workers), which was all due to lower billing rates. This development is concerning, but management said it expects this trend to reverse in the fourth quarter as many competitors are pricing irrationally. The price elasticity of demand for its project/consulting based projects seems to have increased as many players have moved in, attempting to capture a piece of the rebounding business-spending market. Based on its gross margin miss and admitted pricing headwinds, the firm's stock price has fallen 22% since the beginning of April and changed from a fairly priced 3-star stock to a deep 4-star stock.
Catalysts for Stock Price Appreciation: Even though the pricing headwinds that Resources Global hinted at during its fiscal third-quarter release surprised the Street, we believe they are short-term in nature. Over the longer term as business spending starts to grow robustly, Resources should benefit from this increased demand. We believe the near-term compression in its bill/pay spread should reverse as growing customer demand increases end-market inelasticity. Historically, Resources produced average gross margins of 39.0% (39.1% in 2010) and we have modeled average gross margins of 38.8% during our seven-year explicit forecast period. We have modeled our operating margin assumptions to average 11.7% for the next seven years compared to 10.3% during the previous seven years. We assume the firm will be able to leverage its SG&A as it scales with growing project demand. Even if average operating margins are assumed to not scale and average the firm's historical 10.3%, our fair value estimate would be $20 per share, well above current trading levels.
In addition, growing usage of temporary/project-based labor by businesses during the next several years should benefit Resources Global greatly. The typical temporary worker Resources recruits is an individual with 20-plus years' experience in a given industry and a desire to choose what projects to work on. The competency of its temporary workforce augments Resources Global's competitiveness, in our opinion, and makes its employment network a top choice for clients. This should lead to steady top- and bottom-line expansion for the firm during the next several years.
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