• HRnetGroup's core 1Q19 earnings below estimates as gross profit from Singapore ops drops 13%.
• Anticipate downward pressure on earnings on less optimistic outlook.
• Cut core FY19-20F earnings by 8-11%.
• Downgrade to HOLD, Target Price lowered to S$0.85.

Downgrade to HOLD, Target Price Cut to S$0.85

• We downgrade our recommendation on HRNETGROUP LIMITED (SGX:CHZ) to HOLD with a lower Target Price of S$0.85.
• We reduced our core FY19-20F earnings estimates by 11%/8% as we forecast lower earnings in FY19F, largely led by Singapore operations on
  1. lower productive headcount (PHC);
  2. weaker jobs outlook for professional placements; and
  3. less demand from fintech companies in Singapore.
• Although operations in China and Hong Kong are growing, their contribution is small compared to Singapore, which accounts for half of the HRnetGroup’s gross profits. The headwinds in Singapore will likely be a drag on Group earnings.
• Peers’ forward PE valuations have also de-rated since we initiated coverage. Due to a weaker earnings outlook and a lower valuation peg, we thus turn neutral on the stock.

Where We Differ?

• We anticipate core earnings to decline in FY19F mainly from a weaker outlook for professional placements in Singapore. Job vacancy per unemployed person has historically lagged GDP for services producing industries which have declined since 1Q18, indicating a weaker outlook for Singapore jobs going forward.

Potential Catalysts

• The Group is currently sitting on S$304m cash (as of 31 Mar 2019), representing 39% of its market cap. Deployment of funds for inorganic and earnings accretive acquisitions could re-rate the counter.

Valuation

• Our Target Price is lowered to S$0.85 as we reduced our earnings projections and valuation peg to 11x (from 15x previously) on ex-cash earnings, which implies 16x FY19F PE.

Key Risks to Our View

• Downturn in economy leading to lower job turnover and opportunities, departure of team(s) of recruitment consultants and/or top management, competition, execution of inorganic growth opportunities particularly integration.

What's New - HRNETGROUP's 1Q19 Earnings Disappoints

1Q19 earnings disappoints:

• HRnetGroup posted 1Q19 core earnings of S$13.7m (-16% y-o-y), which was below our estimate. Headline earnings of S$19.3m (+18.5% y-o-y) was boosted largely by net revaluation gains on financial assets amounting to S$5.2m.
• Net profit declined after taking out the impact of the revaluation gain. Operating profit was down 8.7% y-o-y to S$18.6m as operating costs increased 3.4% to S$18.4m. Gross profit declined 2.8% y-o-y (-S$1m) to S$35.4m.

Gross profit decline led by flexible staffing on slowdown in Singapore’s fintech sector:

• The drop in gross profit was led by decline in flexible staffing (-4.3% y-o-y to S$12.2m) and other fee-based services such as our provision of payroll services (-56% y-o-y to S$0.3m). Hiring from Singapore’s fintech sector, which has historically used flexible staffing has slowed.
• Recent developments in Singapore included Uber consolidating into Grab as well as exits of bike sharing companies such as Ofo, obike, and Mobike. As such, Singapore’s gross profit declined by 8.6% y-o-y. This was offset by operations in Hong Kong which grew 89.9% y-o-y.

Gross profit flat for Professional Recruitment

• Gross profit was largely flat at S$22.9m for Professional Recruitment segment. Declines in Singapore and Taiwan were offset by an improvement in North Asia. Hong Kong grew 15.5%, Mainland China by 14.4%, Japan 14.1% and Thailand 34.3%.
• The total number of placements fell 3.3% y-o-y to 1,994.

Decline in productive sales headcount:

• The proportion of productive sales headcount (PHC) declined sequentially from 73.8% in 4Q18 to 61.7%. Singapore’s PHC proportion declined to 74% (77% in 1Q18 and 92% in 4Q18), while North Asia fell to 57% (68% in 1Q18 and 65% in 4Q18).
• Singapore’s absolute PHC count declined as well. This led to a 13% y-o-y decline in gross profit to S$18m from Singapore.

Singapore’s macro indicators point to a more challenging outlook for jobs:

• Singapore’s job vacancy to unemployed ratio has historically lagged GDP services producing industries. With GDP growth slowing since 1Q18, we expect job vacancy to unemployed ratio to weaken in the coming quarters as well. As Singapore’s gross profit contribution is significant at 51%, a weaker job vacancy to unemployed outlook should put pressure on the HRnetGroup’s earnings growth going forward. In addition to Taiwan’s weakness, which is the second highest North Asian market contributor, the drag on growth would be even more severe.
• Nonetheless, China and Hong Kong are growing, but we believe growth in both markets is insufficient to mitigate the weakness in Singapore.

• We had already taken a more cautious stance on earnings post 4Q18 results. Yet this quarter disappointed further with a 16% y-o-y decline in core net profit. A disappointing 1Q19 implies that subsequent quarters would need to grow much faster to neutralise the 16% y-o-y earnings decline. Job vacancy per unemployed person has historically lagged GDP for services producing industries which has been declining since 1Q18, indicating a weaker outlook for Singapore jobs going forward.
• Imputing 1Q19’s results including new PHC, revenue and cost assumptions at the current run rate, we have lowered our FY19-20F headline earnings by 1-9%. Core earnings for FY19F/FY20F are reduced by 11%/8%.

• We now anticipate FY19F core earnings to decline, largely led by Singapore on
  1. lower productive headcount (PHC);
  2. weaker jobs outlook for professional placement; and
  3. loss of demand from fintech companies in Singapore.
• Although China and Hong Kong are growing, their contribution is still small compared to Singapore, which accounts for half of the Group’s gross profits. These headwinds in Singapore will likely be a drag on Group earnings.
• In addition, we note that peers’ forward PE valuations have de-rated from 18-22x to 15-17x currently. In line with lower market valuation, we have reduced our peg from 15x ex-cash PE to 11x. This translates to a forward headline PE of 16x, in line with HRnetGroup’s historical average.
• Based on our new valuation of 11x ex-cash PE, we derive a lower Target Price of S$0.85 based on FY19F earnings. With limited upside on the stock, we downgrade our recommendation to HOLD.

Source: DBS Research - 13 May 2019