James Faulkner on Staffline: A good recruit to the portfolio?

Recruitment firm Staffline (STAF) has had a strong run lately (with the shares at 958p at the time of writing they are up 40-fold since their nadir in March 2009). However, last month the firm announced an acquisition that could turbocharge its future performance. But first, a little about the company.

The business…

Staffline is a recruitment and training company which describes its main business as “a specialist supplier of ‘blue collar’ temporary and contract staff”. The largest area of activity is its OnSite offering, which sees the company contracted by clients to recruit, train and manage temporary workers on the customer’s own premises. This furnishes the group with a key competitive advantage enabling it to develop long-term relationships with clients and to better understand their personnel needs.

Its recruitment business now operates from well over 200 locations in the UK, Ireland and Poland, supplying up to 33,000 temporary workers each day. Other areas of operation include Elpis, a national training and consultancy organisation, OSP, a specialist volume recruitment call centre and EOS, which helps the long-term unemployed back in to work through Government Welfare to Work contracts. The latter is a major growth area for the group, and thus provides the backdrop to the recent acquisition.

Recent big deal…

Last month the firm announced the acquisition of Avanta Enterprise Limited for £65.45 million (£45 million net), comprising an initial consideration of £25 million payable in cash on completion, with the remaining £20 million payable in the form of non-contingent deferred consideration. The acquisition was part-funded through a placing of 2 million new ordinary shares at 800p per share to raise £16 million.

Avanta is one of the UK’s leading Welfare to Work and training providers led by a management team with over 30 years’ experience, employing approximately 600 staff and operating through 43 sites. Avanta is a profitable, cash generative business delivering (unaudited) revenues of £70 million, and the acquisition is expected to be significantly earnings enhancing from day one.

Avanta looks like a good fit for Staffline from a strategic point of view, as well as representing good value for shareholders. In addition to creating the UK’s third largest Welfare to Work provider, the deal should provide a better platform for bidding for larger contracts, whilst also providing extra scale and cross-selling opportunities to the firm’s Onsite operations. Meanwhile, the company notes that it secured Avanta on just 5 times prospective EBIT (given Avanta’s contracted revenues in place), which continues a strong track record of securing attractive acquisitions at good value.

Impact on trading…

The impact of the deal for the valuation for Staffline is significant. House broker Liberum put through some hefty earnings upgrades on the back of the acquisition. For the current year to December 2014, it raised its earnings forecast by 32% to 59.5p per share, which suggests a current rating of 16.1 times. However, in FY15 it now sees earnings hitting 69.2p, an increase of 45% on its previous forecast. What’s more, this is followed by another 45% upgrade for FY16, to 72.3p. Staffline has also increased its 2017 target from £30 million pre-tax profit to £40 million (assuming no further acquisitions). According to Liberum, this would imply earnings of over 120p and implies a prospective 2017 multiple of just 8x on the current share price.

Other brokers have since chimed in. Charles Stanley’s revised price target of 1,200p would imply a PE rating of 12 times based upon pre-tax profits of £40 million in 2017. This rating, it believes, is “not that demanding”. Even if Staffline falls short of the £40 million target and reports a profit of, say, £35 million, the 2017 PE rating would still be just 13 times on the broker’s numbers.
That said, “Staffline does have a track record of publishing demanding growth targets and then meeting them”, it added.

Meanwhile, finnCap offers an interesting slant on the risk/reward metrics of the deal. The forecast earnings of the existing contracts to renewal, discounted at the 9% per annum that the broker uses for its group DCF (discounted cash flow), generate an NPV (net present value) of £28 million. The final fixed assets and working capital at termination are forecast by management to be worth £3 million. Hence, according to the broker, the worst-case scenario of no further contract wins or renewals generates a total value of £31 million, meaning that Staffline’s risk from the £45 million cost is only £14 million. “£14 million at risk versus the potential to continue to earn £10 million operating profit per annum following successful rebids and the potential arising from becoming a major supplier (no.3 in the Work Programme) seems like a very attractive proposition to us,” argues the broker.

Conclusion…

With its novel business model and strong track record (pre-tax profits up by 152% between 2008 and 2013 and a 244% rise in the dividend), Staffline is one of the more interesting plays in the UK recruitment sector. With the UK recovery apparently gaining momentum, the recruitment sector could remain a good place to be in 2014. Recent UK employment statistics showed another large fall in the headline unemployment figure, by 133,000 to 2.2 million, which should indicate continued strong levels of trading for recruiters as the demand for quality labour rises. Key risks to the investment case remain the cyclical nature of the recruitment sector and the large exposure to the Government’s Work Programme, which is subject to the actions of future governments.