Few companies are projecting double-digit earnings growth in this economy. For those few that are, it's not surprising when projections are met with a healthy dose of skepticism.
Insperity (NSP) is one of the few projecting healthy growth under a veil of external doubt.
For most of its existence, Insperity has operated a model still foreign to many as a professional employer organization (PEO). In a PEO model, the employee is “co-employed” by an administrative employer, such as Insperity, and the worksite employer. Under its PEO umbrella, the company offers human resource and business solutions, including recruiting, training, employee management, payroll, benefits administration, workman's compensation administration and retirement benefits management.
Insperity has consistently focused its sales energy on healthy small and medium-sized companies. As displayed in this 2013 investor presentation, it profiled businesses based on risk and success criteria.
Thus, Insperity eliminated 61% (40% + 35% of 60%) of its potential client base because they were classified as high-risk and/or struggling. This left only 39% of businesses, considered to be surviving, producing or thriving as well as medium- to low-risk.
In early 2017, Insperity opted to expand its offerings for companies not interested in or not ready for a PEO model, yet still in its target market. It began development of a traditional HR service. By the 2018 second quarter, the offering had been branded Workforce Acceleration. It is defined as a “self-service, human capital management software bundle, plus professional HR support as needed”. Acceleration expands Insperity's reach substantially in its target demographic. The company has declared the offering a “game changer”.
Additionally, in 2018, Insperity developed a focused offering for a mid-market demographic. The company honed in on companies with 150 to 5,000 employees needing customized solutions. This focus, too, enlarges Insperity's reach in its target market. Contracting mid-market clients should accelerate the company's historical growth rate.
Each of Insperity's current solutions is rooted in a push for businesses to outsource and focus on their core business. The company offloads the requirement to be well-versed and competent regarding employment laws, tax regulations and government compliance. Especially for a small to medium-sized business, the idea of being able to focus on the core business while relying on a competent partner to handle administrative duties is appealing. Further, because of economies of scale, Insperity is able to offer more attractive benefits options than individual companies.
Insperity's growth trends of the past four years are enviable. Moreover, it is not expecting any loss of momentum for 2019.
Initially, the company projected the average number of paid worksite employees per month (WSEs) would grow 14-16% to 238,400-242,600, with a midpoint of 240,500.
More paid worksite employees will generate more revenue. But the true measure of growth is in the lower lines of the income statement:
“But as you all know, it isn't about our revenue anyway. It's about the gross profit and the contribution at the operating income line because every worksite employee is a unit of revenue and unit of risk.”
Indeed, Insperity's initial guidance for the rest of the income statement reflected greater growth. Adjusted EBITDA was projected to grow 12-19% in a range of $268-285 million, with a midpoint of $277 million. Adjusted earnings were projected to grow 17-25% in a range of $4.37-4.69 per share, with a midpoint of $4.53.
On May 2nd, Insperity reported 2019 first-quarter results. In line with its projections, the average number of paid worksite employees grew 15% year over year. Revenue for the quarter was $1.15 billion, an improvement of 13.7% over the first quarter of 2018. Adjusted EPS, though, jumped 40.4% year over year, from $1.41 in the first quarter of 2018 to $1.98 in the first quarter of 2019.
With such a stellar performance, Insperity, normally conservative by nature, increased its full-year projections. The adjusted EBITDA range was bumped up from $268-285 million to $276-289 million. This now represents year-over-year growth of 15-21%. The adjusted earnings range jumped from $4.37-4.69 to a range of $4.55-4.80. Compared to $3.75 in adjusted EPS in 2018, this represents growth of 21-28%.
Even Insperity acknowledges such growth is worthy of a dose of hesitation:
“After four years in a row increasing our adjusted EBITDA by more than 25%, a natural question is how sustainable are these strong results. There are four pillars to our business model supporting the sustainability of our high performance: consistent predictable growth, management of price and costs, operating leverage in the share size of our market opportunity.”
The Veil of Doubt
After the company reported its impressive year-end results in February, one SA article warned about the risk of a slowing economy spelled danger ahead:
“However, historically it [Insperity], along with the rest of the PEO industry, are hit hard as soon as the economy starts to slow down.” (emphasis added)
The article referenced the inversion of yield curves in 2000 and 2006 leading to recessions. Thus, it is pertinent to review Insperity's actual performance in those two time frames.
(Source: Author-created from company data)
From 1999 to 2000, the average number of paid worksite employees per month grew 46.3%, from 42,479 to 62,140. The growth rate did slow in 2001 and 2002, but maintained a double-digit clip at 11.8% and 11.3% respectively. The WSE count did slip less than 3% in 2003 but resumed recovery in 2004. By 2005, double-digit growth was back on track. In hindsight, despite broader economic challenges, Insperity's average number of paid worksite employees per month doubled from 42,479 in 1999 to 88,780 in 2005.
Likewise, the WSE growth rate in 2006 continued at a healthy, double-digit clip. It slowed slightly in 2007 and 2008 to 9.6% and 6% respectively, before slipping to a negative rate in 2009 and 2010. Positive growth resumed in 2011. Through this second instance of challenging conditions, Insperity's average number of paid worksite employees per month grew 31.6%, from 88,780 in 2005 to 116,839 in 2011.
In both time frames, the greatest decline in the WSE metric was only 7%. However, Insperity's revenue growth fared far better. Year over year, revenue actually declined only once in the past 20 years. In 2009, it slipped just 4.1%, less than the WSE metric decline of 7%.
(Source: Author-created from company data)
Both metrics do appear to negate the thesis mentioned above. While the PEO industry may have been “hit hard”, Insperity's revenue and WSE metrics, while definitely impacted, were not “hit hard”. Furthermore, the impacts were felt years after the "initial" slowdown rather than “as soon as the economy started to slow down”.
(Source: Author-created from company data)
Prior to 2011, Insperity conducted business under the name Administaff. The culprit for the decline in earnings in 2002 to a loss of $0.11 per share, and the decline in the WSE metric in 2003 was detailed in the 2003 annual report.
“Administaff experienced a significant price and cost mismatch in the benefits component of its business in 2002 due to a sudden, significant step up in healthcare costs resulting from the breach of contract by the Company’s former health insurance carrier, Aetna Life Insurance Company. Not only did this have a significant negative impact on 2002 earnings, but was also the primary driver in the decline in paid worksite employees during the 2003 period, as the increased healthcare costs were passed on to renewing clients. These price increases, when combined with effective benefit plan design and client selection changes, resulted in the significant improvement in gross profit during 2003.”
On the other hand, Insperity pointed directly at the challenging economy in 2009.
“Recent economic conditions have had, and may continue to have, a corresponding negative impact on our operating results as some of our clients may suffer business failures, and others may react to worsening conditions by reducing their employee headcount, lowering their wage and bonus levels, lowering their spending on other human resources benefits and services or determining not to outsource those services to us. In addition, economic conditions may impair our ability to attract new clients. These circumstances have impacted our 2009 results.”
Besides the WSE metric being less, benefits costs were higher.
“This increase was due to increased utilization by active participants, as well as higher claims associated with increased COBRA participation resulting from the severe economic environment and the enactment of the ARRA.”
On the bottom line, Insperity's diluted earnings per share dropped 63%, from $1.79 in 2008 to $0.66 in 2009. The thesis that the company was “hit hard” due to economic challenges would be valid in 2009 in regard to the bottom line. However, again, the impact was not felt “as soon as the economy started to slow down”.
Regardless of a historical review, the applicable question for potential investors is whether history could repeat itself. Of course, Insperity continues to list adverse economic conditions as a general risk to its business. At the worst, adverse conditions could result in reduced levels of employment, compensation, and benefits, as well as decisions to reduce or forego HR outsourcing services. Minimally, economic slowdowns could negatively impact the company's historical onboarding time frames.
“Our organic growth model generates sales leads from five primary sources: direct sales efforts, advertising, third-party channel programs, referrals, marketing alliances, and the Internet... Our selling process typically takes approximately 90 days for clients with less than 150 employees, and 180 days or longer for middle market clients. The process can be extended during economic downturns.”
Yet, Insperity does not appear to be close to waving a caution flag.
To reliably gauge a company's health and optimism, many recommend assessing its capital allocation strategy.
Insperity began paying a dividend in 2005, though its yield is often thin. Still, it is notable that even through the financial crisis, from August 2008 to March 2011, Insperity did not cut or suspend its dividend rate but held it steady. Likewise, a dividend bump is considered a good indicator of a company's optimism regarding its business prospects. So, when the Board announced a staggering 50% increase in the dividend rate on February 28th, it would, sensibly, be considered a strong signal of confidence.
As well, Insperity has an active share repurchase authorization and is actually quite active. The company repurchased 1.2 million shares during 2018 and another 230,000 shares in the first quarter of 2019. It is still authorized to repurchase 1.38 million shares under the program.
Impressively, after both a dividend payment and share buybacks, Insperity had more cash on its balance sheet at the end of its first quarter of 2019, even when adjusted for the withholding for taxes and other payroll deductions.
This shareholder-friendly strategy, reassuringly, is based on the company's anticipation of market opportunities. First, Insperity noted its clients were indeed still hiring in the 2019 first quarter.
“Additionally, we experienced net hiring by our client base during the quarter, although, at lower levels than that experienced in Q1 of 2018.”
More importantly, as highlighted above, offering Workforce Acceleration and the mid-market solution, in addition to the traditional PEO services, means Insperity anticipates gaining a significantly greater market share. The first quarter of 2019 was already bearing signs of traction.
“Our marketing programs continue to be effective, helping to drive consistency in our sales effort. Marketing source discovery calls increased 30% in Q1 and were 2.8 times more efficient, converting sales and self-generated leads.”
And the traction continues into the second quarter. Insperity's client conference in April yielded anecdotal optimism.
“Another important data point for the health of the small and medium-size business marketplace is owner sentiment. In personal interaction at our largest annual client entertainment event in early April, we found a decidedly positive tone around current business conditions and the outlook for 2019.” (emphasis added)
It's quite reasonable to keep an eye on the headwinds facing a company, especially the threat of an economic downturn. As well, it's been said the best predictor of future events is the past.
However, the Insperity facing the next economic challenge is not the same company it was in 2000 or 2006. Not only has its geographical footprint expanded, but more importantly, its arsenal of solutions has been significantly expanded. For that matter, the company has even dropped identifying itself as a PEO.
“We have evolved from being solely a professional employer organization (“PEO”), an industry we pioneered, to our current position as a comprehensive business performance solutions provider.”
The Insperity of today is, simply put, not the Administaff or Insperity of yesteryear.
Disclosure: I am/we are long NSP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I belong to an investment club that owns shares in NSP.