This week the Small Cap team present a brief investment thesis for Konekt (KKT.ASX), one of their favourite holdings.
In our search for under-valued high quality ASX listed smaller companies we occasionally come across an opportunity which truly stands out from the crowd. In this article we discuss a company which is currently trading at less than 10 times FY18 earnings despite expected earnings growth of 15-20% p.a. over the next 3 years driven by solid tailwinds in a defensive industry. And to top it off, the company is led by one of the best management teams we've had the privilege to get to know - and we've met a lot of management teams over the years.
An emerging business model in a sizeable market:
Konekt is a workplace health solutions provider - the company helps companies and healthcare insurers prevent injury and help rehabilitate sick/injured employees so they can ultimately return to work. The company employs more than 800 staff operating nationally from over 125 locations helping people return to the workforce – currently injured and unemployed, but potentially also disabled people looking to enter the workforce. This pool of labour looking to return to the workforce is the supply side of the emerging Konekt model.
As at August 2017 there were over c.200,000 jobs vacant in Australia – the majority in blue collar occupations, with some national firms having in excess of 1,000 jobs vacant at any point in time. This is the demand side of the emerging Konekt business model, as it transitions from its traditional injury management business model. Konekt has strong existing relationships with many of these significant corporate and government employers through its injury management and pre-employment services. Konekt has a significant opportunity to match the labour supply it has access to with the large pool of labour demand/vacancies mentioned. The company is in the relatively unique position of having the resources and scale to place large numbers of employees into vacancies at significant national corporate and government employers. Konekt also has the added advantage of being able to offer a range of other pre-employment screening/assessments and injury and mental health management services to these employers.
The benefits to society of having unemployed, disabled and injured workers return to the workforce (and off government benefits) is likely to see Konekt’s services continue to be well supported irrespective of the government of the day.
Clear revenue and earnings growth drivers:
As a well-funded, well managed & respected ASX-listed service provider, Konekt has a 25-year track record of delivering strong outcomes for employers, employees and society more generally - Konekt’s return-to-work rates are above market at an impressive 94%. As a result, the company is well positioned to continue to take market share from sub-scale, under-resourced competitors operating in each of the three return-to-work verticals (injured, unemployed and disabled).
Konekt also has material margin expansion opportunities looking forward. The company is currently only offering one return-to-work service from each of its offices. Given rent is c.10- 12% of total costs and there is excess space in many offcies, margins and productivity could be significantly improved if Konekt can offer two return-to-work services (eg. both injury and unemployed) from the same office. And in the event that Konekt decides to enter the disability return-to-work market (and are awarded a contract) then it could offer three services from the one location, which would mean further margin upside.
Mission Providence acquisition:
On 29th September 2017, Konekt announced the completion of its acquisition of employment services company Mission Providence – a provider of employment services under the Federal Government’s $1.4bn Jobactive program. This acquisition was partly funded by a $15m capital raise, of which Konekt directors contributed c. $3m.
A key focus at the company’s recent AGM was updating the market on this acquisition. Pleasingly, Konekt management mentioned that there have been no surprises following completion and that the business is tracking to expectations. The acquisition diversifies Konekt’s existing revenue streams, and enhances its ability to provide return-to-work employment services, to complement its existing core offering of delivering return-to-work injury management programs - essentially managing the process of rehabilitating injured workers and getting them back into jobs, where it is the current national market leader.
Konekt management noted the acquisition also provides Konekt with the capacity to enter new or underserviced markets. The logical potential new market here is for the company to provide return-to-work disability employment services – an attractive opportunity with the Federal Government’s 2017 budget highlighting an additional investment of over $3 billion in disability employment services to help people with disabilities get and keep long-term jobs.
Private equity interest in the sector is building:
Interestingly, a private equity fund has recently bought a majority shareholding in one of Konekt’s key competitors – APM, the largest provider of disability employment services to the Federal Government (see here). Apart from this transaction, there has been growing private equity interest in the sector - possibly driven by the potential to capture some of the increasing amount of government funding committed to the disability sector.
Konekt recently confirmed forecast revenue growth of more than 70% and underlying EBITDA growth (excluding one-off items) of greater than 70% for FY18.
On an attractive valuation:
Konekt continues to trade on a PE multiple of less than 10x, with EPS growth (excluding amortisation and abnormals and potential cost synergies) of 15% - 20% p.a. forecast over the next two years – the company offers a powerful combination of value and growth. There would also appear to be very little priced into Konekt’s current valuation to reflect the significant growth opportunities available to Konekt as the business transitions from its traditional injury management focus to a larger, diverse, more integrated employment services company, operating in multi-billion dollar markets.
This is the type of smaller company we get out of bed for, and we look forward to supporting and building upon our shareholding over the long term.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.