AHLS: Resuming Coverage Of AHL Services With "Buy" Rating
Bankers Trust Research/BT Alex. Brown Research
Christopher Feiss,Richard Krygiel
April 22, 1999
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AHL SERVICES, INC. [AHLS] "BUY"
Resuming Coverage Of AHL Services With "Buy" Rating
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Date: 04/22/1999 EPS 1998A 1999E 2000E
Price: 29.75 1Q 0.13 0.21 NE
52-Wk Range: 43 - 18 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): 437 FY(Dec.) 0.91A 1.36 1.73
3-Yr Growth: 25% FY P/EPS 32.7X 21.9X 17.2X
CY EPS 0.91 1.36 1.73
Est. Changed Yes CY P/EPS 32.7X 21.9X 17.2X
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HIGHLIGHTS:
-- We have resumed research coverage of AHL Services, a provider of
outsourced business solutions, with a "buy" investment rating on the
shares and a change in analyst coverage.
-- Our positive investment thesis is based on:
-- Margin expansion from mix shift and well managed operating
expenses.
-- World class management team.
-- 90+% client retention rates -- high repeat revenues.
-- Upside potential from recent acquisitions. Record of beating
estimates.
-- Attractive valuation.
-- Our EPS estimates are as follows:
1Q 2Q 3Q 4Q TOTAL
1999 $0.21 $0.28 $0.44 $0.43 $1.36
2000 NE NE NE NE $1.73
-- Following a gain of more than 290% (annualized appreciation of 120%)
over the last seven quarters, the stock fell more than 30% during the
1Q and, although it has rebounded sharply in the past few weeks, it
remains below our $35 12-month price target. We believe the stock's
weakness is in sympathy to more cyclically-exposed, blue collar
staffing providers (MAN, KELYA, OLS). In our opinion, AHL's solutions
approach (higher level sale) and range of labor and marketing services
effectively insulates the Company from marginal macro-economic
factors.
-- Our 12 month price target is $35 (18% ahead of last night's close) and
is based on a 20 times multiple of our CY2000 EPS estimate of $1.73 -
in line with marketing services averages. We also arrive at an
implied $35 price using DCF analysis. In both cases, we have not
accounted for additional acquisitions (which is unlikely, in our
opinion) or upside from the current operations (again, likely to be a
conservative approach).
DETAILS:
"BUY" INVESTMENT RATING
Our "buy" investment rating is based on the following:
-- Margin expansion from mix shift and well managed operating
expenses.
-- World class management team.
-- 90+% client retention rates -- high repeat revenues.
-- Upside potential from recent acquisitions. Record of beating
estimates.
-- Attractive valuation.
FOUR BUSINESS LINES, ONE STRATEGY
Since its March 1997 IPO, the Company has significantly transformed its
business mix into higher margin business lines. The Company now has four
business lines all centered around its core competency of managing high
turnover, relatively low skilled labor on a contractual basis.
Segment Percent of Total Revenues
1995 1996 1997 1998 1999E
Aviation Services 64% 60% 58% 40% 27%
Facility Support Svcs 36% 40% 39% 28% 30%
Operational Support Svcs -- -- 3% 20% 23%
Mktg Exec'n/Fulfillment -- -- -- 12% 20%
TOTAL 100% 100% 100% 100% 100%
Source: Company reports and BT Alex. Brown Incorporated estimates.
The historical core passenger services and facilities service lines
continue to exhibit strong growth, even as the Company diversifies its
service mix into operational support and marketing execution.
The large majority of the Company's acquisitions have been in higher margin
business lines (operational support and marketing execution/fulfillment).
AVIATION FACILITY OPERATIONAL
MARKETING/
SERVICES SUPPORT SUPPORT
FULFILLMENT
Exec. Aircraft USA Security Lloyd Staffing RightSide
Up
Unicco Security Midwest Staffing Gage
Marketing
SES PIMMS
Tuja
Right Assoc.
EMD
Verfurth
EBIT Margin 3 - 5 % 4 - 6% 6 - 8% 8 - 10%
Source: Company reports and BT Alex. Brown Incorporated estimates.
MIX SHIFT INTO HIGHER MARGIN BUSINESS LINES
The Company has a consistent track record of expanding operating margins.
We believe EPS can grow at 25% over the next 3-5 years, fueled by internal
revenue growth of 20% and significant SG&A leverage.
1996 1997 1998 1999E 2000E
Revenue 210,153 276,013 476,357 771,845 896,466
Gross Margin 25.8% 25.9% 28.6% 28.9% 29.0%
Operating Margin 2.4% 3.9% 5.3% 6.2% 6.7%
Share Count 8,557 10,960 14,419 18,226 18,589
EPS - BTAB $0.25 $0.59 $0.91 $1.36 $1.73
EPS Street $1.36 $1.73
Source: Company reports, First Call and BT Alex. Brown Incorporated
estimates.
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 6.0% 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.
TRACK RECORD OF EPS UPSIDE SURPRISES
Since its March 1997 IPO, the Company has established a consistent record
of EPS upside surprises.
Upside To Consensus
4Q98 +0.01
3Q98 +0.02
2Q98 +0.01
1Q98 +0.01
4Q97 +0.01
3Q97 +0.01
2Q97 +0.01
Source: First Call.
We note that the upside surprises above include consistent, upward
revisions to the EPS estimates suggesting that the degree of out-
performance by this still young company has been even more pronounced.
RECURRING REVENUE STREAM
The Company provides high-value added services to blue chip clients at
fully loaded rates that are frequently 30% lower than the in-house
alternative. The key to this measured differential is superior execution
at the point of service and lower labor costs (many of AHLS's clients are
facing stiffer, union driven pay scales). As a result, AHLS has recorded
93% client retention rates, relationships with a number of its largest
clients that span more than 10 years (see below), and a large base of
recurring, relatively predictable revenue streams.
Long Term Relationships With Top 10 Clients
CONTRACT LENGTH
United Airlines 9 years
Delta Airlines 17 years
British Airways 7 years
BMW 8 years
Mattel 1 year
Ford 7 years
Federal Express 12 years
Northwest Airlines 17 years
Publishers Clearing House 7 years
Reader's Digest 8 years
Source: Company reports.
WORLD CLASS MANAGEMENT TEAM
In late 1994, the Company's founder, Frank Argenbright, 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. The team they have assembled is capable
of directing a much larger operation without losing sight of the strengths
of the current enterprise, in our opinion. While many big company
executives never get the hang of growth company management, we have been
impressed in our visits and our conversations with clients how focused this
group is. In fact, we believe an important competitive advantage that AHL
possesses is related to the balance that top management is striking between
aggressive growth and disciplined financial and operational management.
NAME TITLE PRIOR COMPANY EXPERIENCE
Ed Mellett Co-CEO The Coca-Cola Company, Sr. VP
Tom Marano COO-USA The Coca-Cola Company, VP-Sales
Ernie Patterson Chief Exec-Europe BET, Group Chief Executive
David Gamsey CFO Price Waterhouse, Managing
Director
Henry Anthony VP of HR National Linen Service, VP
Celeste Bottorff VP, Mktg/Strategy Holiday Inn, Dr. of Global
Strategy
Mark Ryall VP, Info Systems Ryder Systems, Group Manager
Source: Company reports.
UPSIDE POTENTIAL FROM ACQUISITIONS -- NEW OPPORTUNITIES IN THE OFFING
The Company has made 13 acquisitions, totaling $328mm in trailing revenues,
since its March 1997 IPO. With the exception of one acquired operation,
all acquisitions since the IPO have met or beat the Company's budgets. The
large majority of these acquisitions have been in higher margin business
lines (operational support and marketing execution/fulfillment). We have
no acquisitions built into our EPS forecasts.
LTM REVENUE PRO FORMA
COMPANY (millions) EBIT MARGIN DATE
Executive Aircraft Svcs 2.4 29.6% May '97
USA Security Services 8.6 7.4% June '97
RightSide Up 6.4 11.3% October
'97
Lloyd Creative Staffing 14.0 6.6% September
'97
Midwest Staffing 8.0 9.6% December
'97
SES Staffing Solutions 16.0 10.4% February
'98
TUJA 16.0 7.0% April '98
Gage Marketing 80.0 8.0% July '98
EMD 50.0 7.0% July '98
Right Associates 17.0 7.0% August
'98
Unicco Security 50.0 6.0% December
'98
Verfurth 20.0 8.0% December
'98
PIMMS 40.0 9.0% April '99
TOTAL SINCE IPO 328.4
Source: Company reports.
The Company is pursuing a whole host of new business opportunities, many
with existing clients. All of these are within the Company's four
strategic service lines.
-- Marketing -- The Company's recently announced PIMMS acquisition should
provide a platform for vertically integrating outsourced in-store
merchandising into the fulfillment business line. Management believes
that immediate cross-selling opportunities exists between PIMMS and
its fulfillment flagship, Gage. This upside is not built into our
model.
-- Fulfillment -- The Company has assumed all of the fulfillment needs of
a growing e-commerce retailer. The Company was awarded the contract,
over a large national fulfillment provider, because it was able to
guarantee 24-hour fulfillment (which the competitor could not). We
believe that, with it expertise in managing warehouse "pick and pack"
operations, the Company is well positioned to partner with the growing
number of e-commerce retailers.
-- Aviation -- Due to success with passenger services for one of its
largest customers, the Company was granted a new support service in
aviation fueling. Our field review of these operations revealed
proprietary environmental and quality assurance procedures which we
believe are leveragable to generate over $100mm in annual revenues
within the next 24 months. This is not built into our model.
-- Facility -- The Company has recently added passenger services for U.K.
railroads. The national rail system in the U.K. was recently
privatized into 26 separate entities. As privatized entities, the
railroads are focusing on making their operations more efficient. We
believe they are strong candidates for outsourcing.
The Company now is doing business with four of them, and plans to increase
its penetration of this large potential customer base. Functions performed
by the Company include access control (security), on-board ticket
collection, and information booth staffing.
"BUY" INVESTMENT RATING
Our EPS estimates are as follows:
1Q 2Q 3Q 4Q Year
1999 0.21 0.28 0.44 0.43 $1.36
2000 NE NE NE NE $1.73
Our 12 month price target is $35 using a 20 times multiple on our CY2000
EPS estimate of $1.73. This is in line with high quality marketing
services names that we follow. It is also more than 2x the current average
PE for a broad group of staffing stocks -- warranted, in our opinion, due
to AHL's superior growth prospects and financial return profile.
Alternatively, a DCF analysis produces a $35 target as well. In both
cases, we have not accounted for additional acquisitions (which is
unlikely, in our opinion) or potential upside from the current operations
(again, likely to be a conservative approach).
$100 MILLION OFFERING STRENGTHENS AHLS' BALANCE SHEET
On January 25, the Company issued 3.5mm shares of common stock: 3.256mm for
the Company and 244,430 shares for Skip Gage (who received the shares in an
acquisition). The proceeds were used to repay debt from acquisitions.
Following the PIMMS acquisition, the Company should have $100mm in
available credit lines with which to continue its acquisition program.
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 32% of its
revenues from its European operations (and 36% 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 4Q, positive currency swings added only
$14,500 to the reported net income (less than $.001 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. |
