Editor's Choice

Can This Small Cap Keep Defying the Experts? (pt. 1 of 2)

Adem is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Kelly Services (NASDAQ: KELYA) is an international workforce solutions provider, headquartered in Troy, Mi. Kelly's shares have bounced wildly from $11.26-$18.09 this year mostly on good or bad employment headlines. However, the stock has outperformed regardless of employment numbers as its beaten analysts expectations the past 11 consecutive quarters; most recently it beat quarterly estimates by 16%!

As I’ve previously stated, Kelly Services is one of my favorite long term opportunities. However, no opportunity no matter how promising should be invested in blindly; I do not endorse “buy and forget” investing even though I do take the long view. With Kelly set to report 3rd quarter earnings on November 7 we’ll use this two part series to take a look at what has helped Kelly beat earnings up to this point (pt. 1) and dig in to what we should be looking for to make sure that they’re staying on the right track (pt. 2).

How You Can Beat The Big Guys

"Don't go after large areas. Don't try to figure out if Merck's pipeline is better than Pfizer's. It's too hard. Go to where there are market inefficiencies. You need an edge. To succeed, you need to go where the competition is low. That's the best advice I can give to small investors."-Charlie Munger

Charlie Munger is extremely quotable but that quote of his is my favorite. In fact, if an individual investor were to base their entire investment strategy off any single quote, I think it'd have to be that one; I really mean it. That is because in order to have an edge on the big guys you really do have to find those opportunities where you have an edge and be on the right side of the facts.

That edge could be from a business being misunderstood or underfollowed, or perhaps it's an edge from the business benefiting from a long term bullish theme that the market hasn't accounted for yet. In the case of Kelly, as I've stated before, it's a business that is vastly misunderstood. That doesn't mean that edge will last forever. Let's take a moment to look back at what gives Kelly its edge and what we should be looking for when it reports earnings to make sure it's retaining it.

The Misinformation Edge

Kelly's edge comes from many different views of one misinformed sentence that goes like this: Kelly Services strictly provides temporary workforce solutions. First, the idea that Kelly only does this has kept the stock price somewhat depressed because investors feel this is a bad market for temp services; not true. In fact, in a recent CareerBuilder.com survey of 2,000 large employers 33% said they planned to increase their temporary workforce for the 4th quarter of this year, an increase of nearly 6% from a similar survey last year. Businesses hire temps before they hire full time employees, so a tentative or sluggish recovery is the sweet spot for temp services.

Furthermore, that sentence is just blatantly false. Kelly has, in recent years, moved away from strictly providing temporary services and these days is in the process of transforming itself into a full-fledged HR service provider. Similar to Barrett Business Services (NASDAQ: BBSI) and Insperity (NYSE: NSP) it is transitioning into a firm that gets every dollar out of its clients by providing multiple tailored HR and Recruitment services including temporary labor. The only difference is that while Barrett and Insperitys business models are understood and they trade at a premium (P/E's of 34.45 and 20.05, respectively) Kelly's business is still in transition and trades at a discount. So let’s take a look at what has been going well so far with their transition as well as areas they’ll need to keep delivering success on.

What Kelly Has Been Doing So Well

Not all revenues are equal and when it comes to service providers, revenue is the last indicator of success we look at. Like I previously stated, this is a good market for all temporary staffing but in the long term Kelly is making an effort to get away from the light industrial business it and companies like True Blue have been known for. Rather it is transitioning into more highly skilled temporary labor business similar to that of Robert Half International (NYSE: RHI).

While a dollar earned is a dollar any way you slice it, light industrial business is the bane of the staffing world for many reasons. First, the margins are notoriously low so even if you obtain the business you need everything to go right in order to be profitable, and second it never goes right. Yes, low skilled industrial labor brings with it injuries, workers compensation cases, unemployment hearings and a bunch of other headaches that eat into the already narrow profits.

Kelly has done a good job recently carving its own niche in the higher skilled labor pie, rather than go after the white collar markets that Robert Half dominates (accounting, creative, etc.) they've decided to leverage their existing client base into the higher margin areas those same clients need including scientific, legal and especially engineering through Kelly Engineering Services. 

Kelly also has recently been able to expand its outsourcing solutions through their service called Kelly OCG; it is through this model of Recruitment Process Outsourcing, Business Process Outsourcing and more that Kelly hopes to become similar to the aforementioned Insperity and Barret. It's also an area where Kelly finds itself transitioning into these services at the same time that competitor and staffing juggernaut Manpower (NYSE: MAN) does so through it's "TAPFIN" service. 

These services are really where Kelly wants to be long term. Through Recruitment Process Outsourcing service they are able to secure all of a client’s staffing business and essentially work as the clients "outsourced HR" department. Kelly guarantees the client that all roles will be filled and through their vendor management service subcontracts out everything they can't fill to other firms. What a great business model; you either get the whole piece of the pie or a piece of your competitors (with no risk, just a fee) all while taking full credit in the eyes of your client.

Finally Kelly has managed to keep its risk in the European markets to a minimum while expanding in fast growing economies. In the staffing business, where you do business is sometimes just as important as the business you’re in.

Nothing Goes up in a Straight Line Forever

If there’s one thing that the crash of 2008 has taught me (and I hope all of you) it’s that nothing goes up in a straight line forever. As of its most recently quarterly report it’s safe to say that Kelly has a distinct edge on its competitors, particularly Manpower and Robert Half, as it transitions its business into profitable areas they just can’t or won’t. Even better, Mr. Market remains mostly oblivious. But nothing goes up in a straight line forever, so we’ll want to make sure that when they report earnings on Nov. 7, Kelly is maintaining its edge. In the second part of this series we’ll look specifically, in more detail, at these areas and Kelly’s record to date as well as what we should expect to see if they’re maintaining their misinformation edge.

 

 


Adem Tahiri owns shares of Kelly Services. The Motley Fool owns shares of Robert Half International. Motley Fool newsletter services recommend Robert Half International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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