On April 2, The Wall Street Transcript interviewed Mike Carney, Senior Vice President at Aperion Group, LLC, on investing in the human capital management space. Key excerpts, with his favorite sector pick, follow:
TWST: Are there any names that you like at this point?
Mr. Carney: My top pick for 2007 is and has been Kforce (NASDAQ:KFRC). The company focuses solely on domestic professional staffing, and they have 50% of their business in IT, where I believe the prospects are fairly robust for the rest of the year. The stock moved quickly from $12 to $14 plus, and then just recently pulled back with a $12 handle. KFRC's valuation is close to the low for the entire group. In terms of valuation, I primarily look at enterprise value to EBITDA for this group, but I also look at it on a p/e basis, as well as with some other measures like free cash flow yield. The stock is certainly cheap in the $12 range. Also, I believe that KFRC has the potential for upside to earnings in later quarters this year. So that's always a positive for stocks.
TWST: Why is it undervalued?
Mr. Carney: The past three quarterly results for KFRC have been at or below expectations, while at the same time many competitors have been beating expectations. So the stock is in the same place that it was 12 months ago even though it's been quite volatile during that time. The reality is that Kforce has continued to grow earnings at 25% or above for a number of years, while continuing to expand its operating margin. But the expectations have been out of whack on a number of occasions. Of course, the stock tends to get a bump upward when investors are confident in the macro picture and a bump downward when there is more caution about the macro picture.
TWST: As you look at the company, where are their opportunities for growth?
Mr. Carney: For some background, KFRC has made four acquisitions in the last three years. The first acquisition was of another publicly traded company, and I thought that acquisition was pretty favorable. It provided KFRC with a number of additional geographies and occupational groups that it wasn't currently in, and it allowed them to leverage cost infrastructure to get a little earnings accretion. I would not consider the next two acquisitions very favorably. These acquisitions did allow the company to further its growth in new areas, including prime government contracting, but they probably haven't been accretive to earnings because the prices paid were too high. Alternatively, I believe the fourth acquisition was definitely a good one. The purchase was of a company called Bradson, which provides prime government contracting mainly in financial-related skills. KFRC provided a lot of information related to the acquisition, which was very helpful to investors. I believe that Bradson has the capability of being a very accretive acquisition, and maybe even more accretive than the amount that I included for 2007. The prospects in this niche of government contracting are very favorable, and it diversifies them away from their other more cyclical business divisions.
Additionally, KFRC currently has a permanent recruitment revenue mix of 7% to 8% of total revenue. Management has said a number of times that they expect permanent recruitment to be 10% to 15% of total revenue at the peak of the cycle. I have not bought into that expectation in this cycle. Yet, with very strong permanent recruitment growth, assuming it's done prudently, operating margins would expand considerably. Furthermore, when I look at the top-line expectations for both myself and for the other analysts on Kforce, they seem fairly easy for the company to meet in 2007. Also, we believe that management is very focused on maximizing profits this year, after making substantial investments in the prior couple of years. These investments dampened profitability in 2006, but we think that management is more focused on increasing profits and less focused on making the total business bigger.