Why This Small Cap Stock is (Eventually) Going Much Higher

By Adem Tahiri - September 7, 2012 | Tickers: KELYA, MAN, RHI | 0 Comments

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Kelly Services, Inc. (NASDAQ: KELYA) is an international workforce solutions provider, headquartered in Troy, Mi. Kelly's shares have bounced around wildly this year from $10.77-$18.09 per share, mostly on employment headlines and numbers. With the most recent quarter in the rear view mirror, this small cap diversified solutions provider, proved once again why it is continuing to improve it's business and deliver on it's strategy. Here are a few reasons why investors should feel confident that this stock will eventually break out.

When Bad Sales are Actually Good:

In its most recent quarter Kelly actually reported a 3.8% decrease in sales with revenues coming in at $1.37 billion, missing Wall Street's expectations of $1.38 billion, yet the stock rose dramatically during intraday trading at one point gaining as much as 16%! This is a perfect example of the old adage not all sales (or growth) are good, Kelly is a services company that has been purposefully repositioning itself into more profitable business lines. Drilling deeper into the 2nd quarter numbers it's clear the company was able to do just that, Kelly reported a .05% increase in gross profit and a 12% increase in earnings from operations all while decreasing the costs of their services by 3.4%.

As CEO Carl Camden stated: “Despite tepid economic growth in the US and recessionary conditions across much of Europe, Kelly made positive strides in the second quarter. We increased our GP, improved our operating profit, and kept a tight lid on expenses — all while delivering solid, sustained growth in OCG and our higher-margin staffing businesses.” Most importantly, through these efforts Kelly handedly beat the .30 cent/share expectations of the 5 analysts following the company, reporting 2nd quarter earnings of .34 cents/share. This marked the companies 11th consecutive quarterly earnings beat!

A Misunderstood Business, a Misunderstood Company:

Kelly's business and that of most companies in the Human Resources/Staffing Services sector has to be one of the most misunderstood on the street. When most people who are familiar with it hear the name "Kelly"what comes to mind is a "temp agency" and naturally when employment numbers are bad (or unemployment is high) the stock takes a hit, even though the company is earning plenty of cash for its shareholders. The reason Kelly and other companies in this sector continue to earn a profit is because their clients hire temps before they are ready to make full time hires. The temporary employment industry is resilient, not only does it profit when corporations are hiring in droves, it profits when they sit on the fence. When corporations  aren't ready to make a full time commitment or pay benefits to their employees, they turn to Kelly. Quite frankly, the company profits from the pain of others.

Furthermore while Kelly does provide temporary services it's also growing its lesser known outsourcing practices which are higher margin businesses and don't have the risks (such as worker's comp) and low margins associated with temporary staffing. Kelly offers Recruitment Process, Business Process, HR and Workforce Outsourcing Services through it's "Kelly OCG" services, similar to rival Manpower's (NYSE: MAN) "TAPFIN." With it's Workforce Outsourcing Services and VMS services Kelly literally just plays the middle man between other temporary agencies and Corporations; making sure other temp agencies play by the rules and provide the best talent at the lowest rate to it's clients. What a business indeed, with no overhead or risks and high margins, it's no wonder Kelly has made an effort to grow this practice! Year over year Kelly's OCG services revenues increased by nearly 24%.

The last misunderstanding is of Kelly's earnings. At a quick glance it looks as though the company's earnings are on course to decline this year from last years outsized $1.80 annual per share to $1.34 (projected) this year. However, last years earnings were aided by federally funded tax benefits for back to work programs; for its latest quarter Kelly's operating earnings actually increased 12%.

All at a Reasonable Price:

Finally, while I'm bullish on the employment services sector as a whole it's clear that Kelly is the best value for a company of its caliber in the industry. Let's take a look at some of the most popular value metrics for Kelly as compared to its peers.

It seems baffling that Kelly would sell at such a discount to its peers, the only thing that can explain it is a misunderstanding of the risks associated with its underlying business. Kelly's stock seems to drop regularly on headlines regarding poor manufacturing numbers despite the growth in its OCG services and professional staffing services (engineering, legal, etc.) that make it less reliant on low margin, manufacturing  temp business. Furthermore, its stock price seems to drop on poor news out of Europe even while peer Manpower does most of its business in recessionary Europe, not Kelly. Kelly on the other hand does nearly 70% of its business in the America's and Asia Pacific. Showing its commitment to emerging economies the company announced in November of 2011 an acquisition of Tradição Tecnologia e Serviços Ltda, a top staffing provider in fast growing Brazil.

Summary:

I firmly believe that good investment opportunities come across only once or twice a year. Kelly Services is a business that is making all the right moves and is wildly misunderstood by Mr. Market. I fully expect this stock to outperform the market once investors fears settle, even if the employement market stagnates, and if unemployement drops below 7% it could be a multibagger. That being said, there is still no need to rush into this one, another poor employment headline should provide an even better entry point into this stock. You should also only buy this stock to hold it for the long term, it's a value play and it may take the market a while to realize its value. When it does, watch out.

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