Value Investors Club / HIREQUEST INC (HQI)

Description

stock trading at nine times trough earnings. Nor do huge growth opportunities and a founder/CEO

with heavy insider ownership, come along with a business that sells for an incredible six times next

year’s earnings. Did I also mention the company just announced a 3% annual dividend and has a

buyback in place as well?

Let me introduce you to HireQuest (NASDAQ: HQI), a franchise staffing company that no one has

ever heard of, but that is sure to be revalued substantially over the next six to twelve months.

HireQuest’s Franchise Model

HireQuest is the only publicly traded staffing company that operates solely on a franchise model.

HQI’s focus is on day laborers. What kind of jobs do HQI’s workers fulfill? HQI workers help load

trucks, move materials on construction sites, hospitality, clean stadiums, help in recycling facilities,

etc. Jobs known as light industrial work.

The total addressable market for staffing in light industrial is 37-40% of the total staffing market.

HireQuest is a big player in their niche, direct dispatch, which is 10% of the light industrial market.

HireQuest workers come to the local office and then are dispatched to work sites and HQI often

even helps the workers coordinate transportation (with COVID there have been some changes in

that often workers go directly to the site). The local franchised office also helps with any

specialized equipment needs such as hard hats or goggles, and at the end of the day workers will

return this equipment, collect pay and check out. HireQuest is primarily in the Southeast,

Northwest, Texas and the Great Plains. HireQuest is not in California or New York, and has a

limited presence in the Midwest, though it is in Indianapolis, Des Moines, Green Bay and East

Chicago).

HQI is a very different kind of franchiser. They lend money to help support a strong franchisee and

do not ask for upfront money for the purchase of a franchise. Instead, a franchisee pays back the

“purchase” of the franchise through revenue and earnings. The company believes it is creating real

entrepreneurs. Many times, HireQuest has cultivated talent inside their network, by getting star

assistant managers to start new franchise branches in adjacent territories. From 2009 to 2018,

almost all of HireQuest’s growth was from lending to aspiring franchisees.

HQI allows franchisees to focus on recruiting day laborers and selling their staffing services to

companies and organizations. HQI provides almost everything else including accounts receivable

management, financing, workers compensation, technology and national accounts. The genius of

the HQI system is to centralize and control the parts of the staffing business that don’t need to be

handled by a franchisee. Once you remove the financial hurdles, you are enabling franchisees to

really just focus on sales and people. HireQuest’s franchise model is one of the few that doesn’t

require capital from the franchisee if someone has the right profile, ambition and hustle.

HireQuest has been honing this business model since founder and CEO Rick Hermanns started

franchising in 1998. There was a corporate structure and name change in 2002. The company’s

system is to strip out layers of management, unnecessary costs and other conflicts that plague

other staffing companies. This enables superior operating margins.

The company made a giant step forward in growth when it acquired a publicly traded microcap

company called Command Center. Then suddenly and very quietly, HireQuest was a publicly

traded company.

HireQuest “Went Public” by Acquiring Command Center

Command Center was a vertically integrated, underperforming staffing company. Just look at the

comparison.

How does a $13 million revenue company acquire a company with $97 million in revenue? Easy,

when its net income is six times the company with the larger sales. This is how far superior HQI’s

business model is to the industry.

HireQuest “merged” with Command Center and then went about converting Command Center’s

operations to franchises. What did this entail? They went to the people actually running the day to

day branch operations and asked if they wanted to be entrepreneurs and also offered existing

franchisees to takeover any overlapping territories. With no money required upfront, they loaned

the purchase of the franchise to these front-line managers, handled the workers comp and

accounts receivable financing and then said go do your job.

What did this mean for those front-line managers of each “branch?” It meant for some their

earnings doubled with no upfront payment. And it meant stripping away layers of useless

management and cutting a lot of unnecessary corporate fat. After five years of earnout, these

franchisees now own the business outright.

The most amazing part of the HireQuest acquisition of Command Center is that it appears as if

HireQuest ended up getting paid to acquire Command Center. How? When you look at how much

consideration Command Center got in the merger, Command Center shareholders received $25

million. However, HireQuest then turned around and “sold” $17 million of franchises to managers

and employees and then also received $15 million of tangible net worth. So, HireQuest was paid

$7 million to acquire a company with almost $100 million in revenue. This brilliant financial move

shows the financial acumen of HireQuest management. That being said, this was actually a good

deal for Command Center as well, as the company could not unlock earnings or value with its prior

structure and management team.

And after the messiness of merger costs and restructuring Command Center into franchises, HQI

was finally ready to showcase its true earnings power in March. And then COVID hit.

Business Model Tested by COVID and Still Profitable in Q2

It is hard to imagine a worse employment market for a staffing company than the second quarter

of 2020, when most of the country went into shutdown. You would imagine HireQuest announcing

big losses and experience financial pain. And yet, you would be wrong. HQI not only was profitable

due to its lean franchise model, but its cash flow and cash balances went up substantially. Since

HQI finances receivables, when business slows down, their receivable balances fall, and cash goes

up. Since the end of the year, HQI’s cash has gone up nearly $10 million, or $0.77 per share.

The capital light nature of the business is really attractive. All that is needed is capital to finance

the accounts receivable and these receivables are highly financeable, making it unlikely that

HireQuest would ever have to raise capital it didn’t want to.

And despite a terrible economic backdrop, HQI is still on track to earn over $0.50 per share in

earnings this year. Any business that can still earn money in this environment has one heck of a

powerful business model.

Approximately $1 Per Share in Earnings Power with Existing Franchise Network

HireQuest earns money primarily three ways:

1. A royalty of 5-8% of a franchise’s sales

2. Accounts Receivable financing

3. Workers Comp Insurance

Before COVID hit, HireQuest’s franchise network was on track to earn $300 million in system-wide

sales in 2020. A rough guide is that HQI should earn in post-tax earnings anywhere from 3% to 5%

of systemwide sales. Using a base case of 4% on $300 million, nets the company close to $0.90 per

share in earnings, and possibly over $1 per share if margins are on the higher end of the range.

The company’s best quarter is typically Q3, while Q2 and Q4 come next and Q1 is the weakest. It

has to do with how many working days there are in any quarter and weather is a factor as well.

The best weather around the country is Q3.

HireQuest could see a surge in its earnings if a big infrastructure spending bill comes through. It

may not matter if it is the Trump bridge and highway plan or the Biden Green New Deal,

infrastructure spending would be a big boon to the company.

Huge Opportunity to Grow Through Consolidation and Conversion to Franchise Model

But beyond the economy recovering or an infrastructure bill, the company’s big blue-sky

opportunity is to roll up mom and pop staffing companies and convert them to its powerful

franchise model.

HireQuest recently hired an investment banker from D.A. Davidson as a full time director of

corporate development (link here: Corporate Development Hire) to accelerate the hunt for opportunities. If you read the deal proxy, you can see that D.A. Davidson was the investment banker for the Command Center side of the deal. It is fascinating that an investment banker for the other side of the deal has now left his investment banker job to work

full-time for HireQuest. This seems to be pretty telling and significant.

Specifically, the company may want to expand outside of direct dispatch into the broader light

industrial market to compete directly with Addecco (SW: ADEN) and Manpower (NYSE: MAN), but

on smaller accounts. Those giant companies don’t normally want to waste too much time or effort

on small jobs, but with its mean and lean franchise model, this could be a rich vein for franchisees

of HireQuest.

This is why the company is public and not a private entity, it can develop a powerful roll-up model

and sit back and print money. The light industrial market is a $58 billion market. If HQI can take an

additional ½ of one percent of the market through organic growth and acquisitions, it could add

$300 million in system wide sales, doubling its earnings potential.

At a high level, HireQuest basically organizes large pools of unskilled and semi-skilled workers. The

company is now asking itself, beyond its vertical, what other areas could it replicate its model.

There may be opportunities in janitorial, security guards and truck drivers. The opportunity here is

enormous if HireQuest can figure this out.

CEO/Founder and Insiders Own Over 65% of the Stock

All of this is driven by Richard (Rick) Hermanns, a founder/CEO, who started the very first version

of HireQuest in 1991, almost thirty years ago. The official version of HireQuest launched in 2002.

Eighteen years later, he now runs a publicly traded company in which he owns a hefty 43% stake.

With decades of experience, management has a keen understanding of the industry and the

opportunity to grow. As large shareholders they also understand capital allocation and the

importance of shareholder value. Just remember how they were essentially paid to acquire

Command Center. This is the kind of team you want to invest with.

While the stock is illiquid, they still view their stock as cheap and initiated a buyback. The company

recently started paying out a solid 3% dividend. I believe the only reason, HQI is not paying out

more is the opportunity to acquire mom and pop shops. If for some reason, the acquisition

opportunities do not materialize or do not materialize at the right prices, I expect the dividend to

jump.

The biggest risk in investing in an illiquid microcap is that your money becomes trapped. With

HireQuest’s aligned management and a nice dividend and buyback, the risks are much lower of

being stuck in a value trap.

Short Term Opportunity to Acquire Shares from Legacy Command Center Shareholders

Let’s face it, this is a really illiquid stock right now because it is so closely held. The stock trades

five thousand shares a day. However, this idea is timely because there are a few legacy Command

Center shareholders who have been selling the stock around $6.50 to $7 per share. It is my belief

that these legacy shareholders have created a short-term opportunity to buy somewhere between

500,000 to 1 million shares and this is what has been keeping the valuation so low.

These long time Command Center shareholders simply do not understand the new company or

franchise system and how profitable and powerful it can be. Nor do they appreciate the valuations

such successful franchise companies achieve when it becomes painfully obvious to market

participants.

This is why HireQuest is so interesting right now, because once this supply is taken, the stock will

move higher quickly.

Valuation is Absurdly Cheap

This stock is illiquid, I get it. But the valuation is absurd. HireQuest has a pristine balance sheet

with $1.67 per share of cash and notes receivables. My estimate of this year’s trough earnings is

$0.55 per share, meaning the company sells for nine times trough earnings. My estimate of next

year is $0.88 per share, meaning the company trades at an absurd six times next year’s estimate or

what the company would have earned in 2020 without the impact of COVID.

Comparatives are hard for HireQuest as most competitors are poorly run, have complicated

financials or are giant companies.

One example is BG Staffing (NYSE: BGSF), another microcap staffing company that has a market

cap of around $100 million, but it also has over $40 million in long term liabilities, so BGSF’s true

enterprise value is $140 million. The company’s financials are really a mess, as they report

“adjusted earnings” that exclude technology fees, transaction fees, amortization, stock comp and

more.

BGSF had been seeing declining earnings before COVID struck and yet still trades for 13 times this

year’s earnings estimate that excludes a lot of true costs and 11 times next year’s numbers and

that is without taking into account the messy financials or the extra $40 million in debt.

Giant staffing company, Manpower, sells for 27 times this year’s trough earnings and 14 times

next year’s estimate. But even this is a poor comparison because Manpower’s margins are so

much lower than HireQuest.

The magic of HireQuest is its franchising margins of 50% and the ability to make money in even the

toughest of environments.

Some successful franchises you may be familiar with are Domino’s Pizza (NYSE: DPZ) which sells for

35 times earnings as does McDonald’s (NYSE: MCD). Super successful franchise companies with

growth sell for outsized multiples. And this is where future acquisitions could really propel the

stock. If they can execute on acquisitions, investors will reward the company with a giant

valuation.

Even with more moderate assumptions though, the right valuation multiple for HireQuest is

probably not to sell for six times next year’s earnings.

The potential earnings power of HireQuest is simply enormous. The stock could easily be worth

multiples of its current stock price.

Risks

This is an illiquid stock and only averages 5,000 shares a day. Illiquid stocks can make exaggerated,

volatile moves when people want to buy and sell. Buyer beware.

The CEO and insiders own the majority of the company and there is always the risk that they do

things that benefit themselves at the expense of shareholders. Having said that, I have found

nothing alarming, and the recent actions around a dividend and buyback show a commitment to

returning shareholder capital.

There are some related party issues to consider and be comfortable with. The CEO’s children and

the other large owner of stock Ed Jackson own 25% of the franchises (though they do not own

them outright, they own interests in them). This is an outgrowth from the financial crisis of 2008,

when they had to acquire these franchisees. All of this is disclosed in the company’s 10K. I am

confident that the company has strong independent board members, and this has been properly

vetted. But it is worth paying attention to, especially if some disclosures change.

Summary

HireQuest is not only a phenomenal business, it has a superior business model with a long runway

for growth that is run by a Founder CEO. Thanks to COVID and a few legacy Command Center

shareholders who may not appreciate the earnings power of HQI’s business model, investors have

the chance to invest in the unimaginable, a company with 50% operating margins trading at a

single digit earnings multiple. You just have to accept that the stock is a microcap and illiquid. But

with a 3% dividend and a heavily aligned Founder CEO with a commitment to growth, it is a small

price to pay. And HQI may be just the best low risk way to invest in the recovery of the economy.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

-Solid Q3 earnings

-Acquisitions and growth

-Infrastructure Spending Bill

-Revaluation and any coverage for investors/analysts

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			2020	2021
Price:	6.88	EPS	0.55	0.88
Shares Out. (in M):	14	P/E	0	0
Market Cap (in $M):	94	P/FCF	0	0
Net Debt (in $M):	-23	EBIT	0	0
TEV (in $M):	71	TEV/EBIT	0	0