BTAB from last week:
BT Alex. Brown Incorporated
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AHL SERVICES INC. [AHLS] "BUY"
1Q EPS Ahead Of Expectations At $0.22--Adding $0.01 To Our 2000 EPS
Estimate
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Date: 04/30/1999 EPS 1998A 1999E 2000E
Price: 30.25 1Q 0.13 0.22A NE
52-Wk Range: 43 - 17 2Q 0.18 0.28 NE
Ann Dividend: 0.0 3Q 0.30 0.44 NE
Ann Div Yld: 0.00% 4Q 0.30 0.43 NE
Mkt Cap (mm): 548 FY(Dec.) 0.91 1.37 1.74
3-Yr Growth: 25% FY P/EPS 33.2X 22.1X 17.4X
CY EPS 0.91 1.37 1.74
Est. Changed Yes CY P/EPS 33.2X 22.1X 17.4X
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HIGHLIGHTS:
--Company reported 1Q EPS of $0.22 (up 69% yr/yr), ahead of the Street
consensus and our estimate of $0.21. Beat our estimate on higher
revenue and margin expansion, reflecting stronger performance in
marketing execution/ fulfillment than we had modeled.
--Company had strong internal revenue growth of 23%. Revenue was up 102%
yr/yr to $170.6mm versus our $165.6mm forecast.
--Gross margins were up 420bp to 29.8%, ahead of our 28.0% forecast, while
operating margin expanded 140bp yr/yr to 4.7%, ahead of our 4.6%
forecast. This shift reflects the Company's shift in business mix
toward marketing.
--The Company announced that COO Tom Marano will become President and COO,
Marketing Support Services. We view this move as an indication of the
Company enhancing its focus in marketing, fulfillment and e-commerce.
Ron Clarke, previously with ADP, will become COO, U.S. Outsourced
Services.
--The Company announced the acquisition of $3.3mm revenue MM Zeitarbeit
GmbH ("MM"), a German operational support service provider, increasing
its customer portfolio in the Bavaria region. Future acquisitions are
not built into our forecast.
--We are increasing our 1999 EPS estimate to $1.37 from $1.36 to account
for the 1Q EPS overage. We are increasing our 2000 EPS estimate to
$1.74 from $1.73 to account for the MM acquisition.
--Our 12-month price target is $35 using a 20x target multiple on our
CY2000 EPS estimate of $1.74, in line with marketing services averages.
Our investment rating remains "buy."
DETAILS:
1Q EPS UP 69% YR/YR TO $0.22, AHEAD OF OUR $0.21 FORECAST
The Company reported stronger revenue than we had forecast and, in general,
revenue momentum is running ahead of our earnings model. Internal revenue
growth was up 23% yr/yr. Revenue was up 102% yr/yr to $170.6mm versus our
$165.6mm forecast. We estimate that the revenue run rate, including two
recent acquisitions (see below), is about $700mm.
Gross margins were up 420bp to 29.8%, well ahead of our 28.0% forecast,
while operating margin expanded 140bp yr/yr to 4.7%, ahead of our 4.6%
forecast. This shift reflects the Company's shift in business mix toward
marketing execution and fulfillment, and particular strength from Gage
during the quarter. Gross margins within each service segment were stable
to up yr/yr in the 1Q.
Our EPS estimates change as follows:
1Q 2Q 3Q 4Q Year
Old 1999 0.21 0.28 0.44 0.43 $1.36
New 1999 0.22A 0.28 0.44 0.43 $1.37
Old 2000 NE NE NE NE $1.73
New 2000 NE NE NE NE $1.74
We are adding $0.01 to our 1999 EPS to account for the 1Q EPS overage. We
are increasing our 2000 EPS estimate $0.01 to account for the MM
acquisition.
12-MONTH PRICE TARGET OF $35
Our 12-month price target is $35 using a 20x target multiple on our CY2000
EPS estimate of $1.74. Our target P/E multiple is in line with marketing
services averages. Our investment rating remains "buy."
ORGANIZATIONAL CHANGE
GOAL: DRIVE MARKETING EXECUTION/FULFILLMENT GROWTH
The Company announced that COO Tom Marano will become President and COO,
Marketing Support Services. Ron Clarke, previously with ADP, has been
hired as COO, U.S. Outsourced Services (aviation, facility and operational
support). Clarke was previously with ADP as President, Electronic Services
Division. Marano will transition the core business responsibility to Clarke
and both will report to co-CEO Ed Mellett.
We believe Tom Marano has clearly made a significant impact over the past
four years in driving sales growth in the Company's core business.
Accordingly, we view his shift into Marketing as an indication of the
Company's enhanced focus into marketing, fulfillment and e-commerce. The
Company has doubled its e-commerce client base in the past year (totaling
25 to date), and we believe the Company is well positioned to partner with
the growing number of e-commerce retailers.
TWO ACQUISITIONS SO FAR IN 1999 TOTALLING $43MM IN ANNUALIZED REVENUES
On 4/30/99, the Company expects to close the previously announced
acquisition of $40mm revenue PIMMS. The PIMMS acquisition also exemplifies
the Company's increased emphasis in the Marketing Execution/Fulfillment
business line. PIMMS provides in-store merchandising and allows the
Company to vertically integrate outsourcing solutions for its manufacturing
and retail clients. Management believes immediate cross-selling
opportunities exist between PIMMS and its fulfillment flagship, Gage.
On 4/30/99, the Company expects to close the acquisition of MM Zeitarbeit
GmbH ("MM"), a $3.3mm revenue German operational support provider. The
acquisition adds density in the Bavaria region currently occupied by last
year's Tuja acquisition and increases the customer portfolio in the region.
MANAGEMENT DELIVERING ON STRATEGY OF LEVERAGING CORE LABOR MANAGEMENT
COMPETENCY
Management has been delivering on its strategy of moving the Company into a
variety of contract labor markets. While the Company's traditional
aviation security business continues to grow revenues in excess of 20% and
has very strong long-term growth potential, management is working to extend
its competency in managing relatively low skilled, low wage labor into
other new areas.
The Company has significantly transformed its revenue mix since its IPO:
Revenue Mix At IPO Actual Pro Forma
3/26/97 12/31/98 All Acquisitions
Passenger Services 56% 40% 26%
Facilities Management 40% 28% 29%
Operational Support 4% 20% 23%
Marketing Execution 0% 12% 22%
Source: BT Alex. Brown estimates and Company reports.
We believe that growth in operational support via acquisition (i.e., light
industrial) will be primarily in Europe, rather than the U.S.
The historical core passenger services and facilities services lines
continue to exhibit strong growth, even as the Company diversifies its
service mix into operational support and marketing execution.
BUILDING PRESENCE IN STRATEGICALLY TARGETED MARKETING EXECUTION MARKET
Company management has consistently indicated a desire to build its
presence in the marketing execution market. Up until the PIMMS
acquisition, this has been primarily in the form of providing fulfillment
services.
The Company entered this market in 4Q97 with the acquisition of RightSide
Up. The Gage (3Q98) and PIMMS acquisitions, bring total annualized
revenues in this service line to about $150mm a year (22% of the revenue
run rate for the Company) and add vertical sales capability to the business
line.
NEW BUSINESS OPPORTUNITIES
The Company is pursuing a whole host of new business opportunities, many
with existing clients, all within the Company's four strategic service
lines.
During the 1Q the Company was awarded $28mm in annualized new contracts --
its largest per quarter total ever -- including a $12mm contract with
the New York Port Authority, its largest contract to date.
The Company has also secured $14.5mm in annualized new contracts scheduled
to begin in the 2Q, which should help provide momentum for the balance of
the year.
INCREASING PRESENCE IN STRATEGICALLY TARGETED OPERATIONAL SUPPORT MARKETS
Company management has consistently indicated a desire to build its
presence in the operational support markets. The Company is working to
extend its core competency of work force management for labor intensive
functions into additional services offerings with higher operating margins.
The initial forays into this space were Lloyd Creative Staffing, Midwest
Staffing and SES, all in the U.S. These are all light industrial staffing
companies, most of whose work is done on a temporary staffing basis.
The Company has expanded the operational support service line into Germany
with the acquisitions of Tuja, EMD, Verfurth and MM, all of which provide
industrial staff. In Germany, business is usually done on annual
contracts, providing more stability than traditional temporary light
industrial staffing. We expect future acquisitions in this service line to
be in Europe rather than in the U.S.
Total annualized revenues in this service line are now about $170mm a year
(23% of the revenue run rate for the Company).
MIX SHIFT HAS POWERFUL MARGIN IMPLICATIONS
We expect the Company's operating margin to continue to move toward the
high single digits and low double digit levels recorded by labor driven
marketing services models with which we are familiar. Without any mix
shift, we think the Company should be able to generate 6.2% operating
margins in 1999 (up from 5.3% in 1998) driven by revenue increases
leveraged across the existing office network and continued tight management
of relatively more fixed overhead. The mix shift strategy should push
operating margins even higher as the Company moves into businesses with
higher operating margin potential.
FUTURE ACQUISITIONS PROVIDE ADDITIONAL UPSIDE POTENTIAL TO ESTIMATES
Since its March IPO, the Company has acquired fourteen companies with about
$332mm in annualized revenues. While we have not modeled additional
acquisitions into our forecast, growth via acquisition is part of the
Company's strategy.
The Company is currently evaluating a number of companies, each with
revenues in the $10-50mm range.
WHY WE LIKE THIS STOCK
-- Large And Growing Market Opportunity -- Overall market opportunity
approximates $100 billion, with aviation-related services alone on the
order of $50 billion. AHL is the beneficiary of outsourcing and vendor
consolidation trends in aviation as well as other industrial markets.
-- Recurring Revenue Stream -- AHL has a very strong track record in
retaining clients. Historically, over 90% of the Company's annual
revenues have been generated from existing clients. The Company has an
average retention rate of approximately 93% over the last three fiscal
years. The Company has over 1300 contracts (with an average term of
three years) to provide services and has established long-term
relationships with its major clients.
-- High Value Added -- AHL provides its clients with a high degree of
value added by performing a task for the client more cost effectively
than the client can. AHL achieves this through (1) lower direct labor
costs on an hourly wage basis, (2) greater efficiency in managing the
task, thereby using fewer labor hours, and (3) lower labor turnover
rates than its clients typically experience in-house. On average, the
Company saves its customers 30% over their internal costs. The
Company's blue chip client list (British Airways, United Air Lines,
Nike, America On-line, Procter & Gamble, Delta, etc.), we believe, is a
testament to the quality of its operations.
-- World Class Management Team -- In early 1995, the Company's founder
developed and professionalized the management team by recruiting senior
executives with both industry and functional expertise. The co-CEO, Ed
Mellett, is the former President of Coca-Cola USA. This team has
created a corporate infrastructure that is leverageable to provide rapid
growth.
-- Four-Legged Growth Strategy -- The Company's strategy is designed to
exploit its core competency of managing labor intensive, low-skilled,
repetitive tasks on an outsourced basis for its clients. We believe the
Company should consistently generate internal revenue growth on the
order of 15-20% as it (1) increases the amount of business it does with
existing clients by cross-selling its various product lines and expands
into new markets, (2) aggressively adds new clients in existing product
lines and (3) adds new clients in new product lines. Acquisitions, the
fourth source of growth, could push revenue growth up to 25+%, although
we have no acquisitions built into our forecasts.
RISKS
--Move from Contracted Revenue Streams: As the Company shifts the mix
toward higher margin fulfillment and industrial staffing service lines,
the revenue stream will become somewhat less contractual in nature than
the contractual weekly hour basis of the bulk of its business. For
example, fulfillment contracts are usually paid on a per stock keeping
unit packed basis. This puts the Company "at risk" for volume.
Industrial staffing contracts, while billed on a per hour basis and with
generally steady usage at a client site, do not bind the customer to
fixed contractual weekly hours. We note that many of the marketing
service categories that AHL has tapped are growing faster than the core
aviation outsourcing markets. Also, these segments remain highly
fragmented and poorly served suggesting that AHL's national account
capabilities and high service standards will be meaningful competitive
advantages and at lower risk from client loss or down turn.
--Customer Concentrations: The Company's top-three clients generated 30%
of revenues in 1998. The largest, United Air Lines, generated 13% of
revenues. Over time, we expect the Company to grow around this core
customer base. (We estimate the top-three clients will represent about
15% of 1999 revenues.) We also note that it has multiple contracts with
each of its major clients (e.g., 116 with the top-three clients) and
that the Company has never lost a contract for service quality reasons.
Finally, we would point to the long-term relationships the Company has
had with its major clients (top-ten clients average 9 years with the
Company).
--Dependence on Aviation Industry: Aviation customers represented 39% of
the revenue base in 1998. However, this is down from 72% in 1995 and on
a pro forma basis, the figure is about 28%. Importantly, passenger
count is not a driver of the Company's business--it is not tied to
airline load factors. Over the medium-to-long term, it is the number of
departures that drives the aviation industry's demand for AHL's
services.
--Currency Exposure: The Company generates approximately 31% of its
revenues from its European operations (and 35% of operating profit). In
Europe, AHL receives revenues and pays expenses in local currencies, so
the Company experiences little foreign exchange risk in its operations.
Changes in exchange rates may affect the Company's reported results --
in the 1Q, negative currency swings were only $36,000 dilutive to
reported net income ($.002 per share). The British Pound and the
Deutsche Mark, which are relatively stable currencies, account for the
preponderance of the Company's European activities. The Company does
not currently engage in hedging transactions to reduce exposure to
fluctuations in foreign currency exchange risks.
--Managing Growth: The Company has grown revenues more than fourfold over
the past five years and is growing internally at 20+% without much
addition to SG&A. AHL is adding new products and extending its
geographic reach. And the Company has made a number of large
acquisitions relative to the size of the core operations. All of this
sets up a number of potential problems for a young Company.
Fortunately, Mr. Argenbright has assembled a management team with large
company experience that should be able to deal with the increasingly
complex business model without sacrificing the nimbleness that has
characterized AHL to date.
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