With Quiver Quantitative’s recent institutional holdings data, we can see that hedge funds and asset managers have been increasing their holdings in Insperity Inc. (NYSE: NSP). Firms such as Blackrock, Bank of America, and Lakewood Capital Management have all added to their NSP positions recently. Most notably, Blackrock increased shares held by 1.84% (as filed on 6/30), bringing their total NSP holdings to 5,676,022 shares worth around $566.5 million dollars at current market prices. With this in mind, we took a closer look at some of the reasons why investors may be bullish on Insperity Inc.
Earlier this month, Insperity Inc. posted their second quarter earnings results for fiscal year 2023. Revenues in Q2 of FY23 were up 10.7% to $1.6 billion dollars, largely due to a 7.2% increase in paid WSEEs (worksite employees) and a 3.2% increase in revenue per WSEE. The business executed on their growth strategy plan, with client retention coming near forecasted levels despite a challenging business environment through the first few months of 2023. On a worse note, however, second quarter net income and diluted EPS were down 62% to $12.9 million dollars and $0.33 per share, respectively. However, it must be noted that on a YTD (year-to-day) basis, net income and diluted EPS were up 4% to $107.5 million dollars and $2.78 per share, respectively. Looking at capital allocation priorities, management also increased the share repurchase authorization by 2 million shares, or around 5.25% of current shares outstanding. With these earnings results in mind, we believe that Insperity Inc. is a compelling investment opportunity currently trading at a fair valuation.
Insperity Inc. provides an array of human resources and business solutions to help drive increased business performance. Since the business’ formation in 1986, Insperity Inc. has expanded from solely being a professional employer organization (“PEO”) to a comprehensive business performance solutions provider. Insperity’s long-term strategy is to provide specialized human resources service offerings to small and medium-sized businesses across the United States, while also leveraging the business’ buying power and expertise to add valuable services to their clients. The business’ “PEO HR Outsourcing Solutions” covers a wide range of human resource functions, including employee benefits, workers’ compensation, payroll and employment administration, performance management, and government compliance solutions and services. In addition to these human resources solutions, Insperity also offers traditional human capital and payroll services through their “Workforce Acceleration” solution.
The professional employer organization or “PEO” industry, an industry that Insperity Inc. pioneered, evolved in the 1980’s in response to an increasingly complex regulatory and legal environment for small and medium-sized businesses and employers. Since PEOs provide employer-related solutions and services for a wide-range of employees, they can achieve economies of scale, allowing Insperity to perform employment-related functions much more efficiently than an individual employer. Additionally, PEOs like Insperity are able to provide greater employee benefits and devote more attention to human resources management than individual employers.
While the PEO industry is highly fragmented and competition has intensified over the years, management believes that Insperity is one of the largest PEO service providers in the United States. Management acknowledges that competitive factors in this industry include choice and quality of benefit packages, price, reputation, quality of services, and scope of services. Management also acknowledges that reputation, regulatory expertise, national presence, financial resources, risk management, and information technology capabilities separate the leading PEOs from the rest of the industry, and management believes they compete fairly well on all of these factors. Management believes that Insperity largely competes with the traditional in-house provision of human resources services (meaning they primarily compete with companies that conduct HR activities in house), however, Insperity also competes with the PEO arms of large national business services companies like ADP and Paychex.
Management is solid, and their capital allocation priorities do a good job of aligning shareholder and management interests. Management likes to repurchase shares under Insperity’s repurchase program. In 2022, management repurchased 671,468 shares. Additionally, in 2021, management repurchased 424,509 shares under the repurchase program. On December 31, 2022, management was authorized to repurchase up to 1,032,160 shares under the current share repurchase program at the time, however, that has since been increased to 2 million shares as of Insperity’s FY23 Q2 earnings earlier this month. In addition to share repurchases, Insperity also pays out dividends as well. In 2022, Insperity paid out $76.6 million dollars worth of dividends. As we can see, management has superb capital allocation priorities that prioritize shareholders, massively increasing shareholder value through dividend offerings and aggressive share repurchases.
In terms of incentives, management is incentivized well, with a compensation structure that does a great job of aligning shareholder and management interests. Insperity’s NEO compensation structure includes an annual cash salary, along with an at-risk compensation structure that includes a variable cash-based bonus and long-term equity incentive rewards, in addition to benefits. The variable cash bonus rewards NEOs for achieving annual company performance goals, whereas the long-term equity incentives rewards are paid out in accordance to how well long-term performance goals are met. These equity rewards do a great job of aligning shareholder and management interests, as management builds up equity in the business. The NEO compensation structure puts a lot of the total compensation at-risk in equity rewards, so management is incentivized to perform well (and have share performance do well as well), as it directly ties into their compensation. Additionally, these equity bonus rewards also do a great job of retaining NEO talent long-term. As management builds equity in the business, it becomes increasingly harder for them to leave. We believe that it is a great principle for investors to seek out companies where management feels like a partner to shareholders, and we believe that Insperity Inc. is a great example of this.
Insperity Inc. is a very efficient business. The business currently operates at a LTM ROE of 221.4% and a LTM ROIC of 43.7%. With a WACC of 9.2%, Insperity operates at a ROIC to WACC ratio of around 4.75x, a relatively high figure that showcases the business’ ability to reinvest cash back into the business at rates of return far higher than the business’ weighted average cost of capital. When a business is able to reinvest cash back into the business at high rates of return like Insperity, we consider these compounders, businesses that are able to rapidly compound intrinsic value over a long period of time, handsomely rewarding shareholders. Looking further at efficiency metrics, we can see that this ROIC figure has actually fallen over the last few years, potentially signaling that the business may be losing a competitive edge in the industry that they operate in (i.e. new entrants into the industry). In 2013, Insperity operated with a ROIC of 64.5%, compared to today where the business operates at a LTM ROIC of 43.7%. While this falling ROIC may signal problems for the business, we feel more optimistic, especially as ROIC is still relatively high and the business still operates at a high ROIC to WACC ratio.
Analyzing Insperity’s income statement, we can see some stellar sustained growth in revenue, gross profit, and earnings within the last decade. Since 2013, Insperity has grown revenue at a CAGR of around 9.75%, with gross profit growing at a CAGR of around 9.25% in that same time frame. Gross margins over the last few years have stayed relatively flat, hovering around 16-18% within the last decade. In terms of earnings, Insperity has grown EBITDA at a CAGR of around 12% since 2013, with EPS growing at a CAGR of 20.3% in that same time frame. This large growth in EPS over the last decade can largely be attributed to share repurchases. Insperity is a cannibal, decreasing shares outstanding by 25.2% since 2013.
Looking at Insperity’s balance sheet, we can see that the business operates in sound financial health. Insperity currently has $580 million dollars worth of cash and equivalents on hand, with an additional $36 million dollars in short term investments, bringing total cash and short term investment holdings to $616 million dollars. With only $369 million dollars in long-term debt, the business operates at a very healthy long-term debt to cash ratio and a net debt of $-196.6 million dollars, signifying that the business operates with more cash than debt on their balance sheet. As we can see, the business has plenty of runway to pay off its debts, and with an excess cash reserve of almost $200 million dollars, they have plenty of cash to reinvest back into the business, repurchase shares, or offer / increase a dividend.
Looking at Insperity’s cash flow statement, we can see some stellar sustained growth in net income and free cash flow, showcasing the business’ operational efficiency. Since 2013, Insperity has grown net income at a CAGR of around 17.2%, with free cash flow growing at a CAGR of 22.75% in that same time period. This growth in free cash flow can largely be attributed to expanding free cash flow margins. In 2013, the business operated at a free cash flow margin of 1% of revenue, compared to today where the business operates at a free cash flow margin of 3% of revenue. While these free cash flow margins are still relatively low, it is still a positive sign that free cash flow margins have expanded within the last decade. As free cash flow margins continue to expand, the business will generate more free cash flow, which it can then use to repurchase shares, offer / increase a dividend, or reinvest the cash back into the business at high rates of return, rapidly compounding intrinsic value and handsomely rewarding shareholders.
After conducting a reverse discounted cash flow analysis, we can see that Insperity Inc. is trading at share prices that imply a 5.97% growth rate (CAGR) in free cash flow over the next ten years, using a perpetuity growth rate of 3% (largely in line with US GDP growth) and a discount rate of 10%. We believe that this growth rate is pretty cheap based on the fact that Insperity was able to grow free cash flow at a CAGR of 22.75% within the last decade and free cash flow margins expanded over that time period as well. With Factset placing a 15% LT (long-term) growth rate on the business (based on analyst estimates), we further believe that this 5.97% growth rate is cheap. While past performance does not translate into future results, we believe that expanding free cash flow margins will act as a catalyst for free cash flow growth going forward. If the business is able to continue to expand free cash flow margins (we would want to see a free cash flow margin expansion into the 5-10% range), it is very possible that the Insperity will be able to far exceed the free cash flow growth rate implied by current share prices. Additionally, with consensus estimates placing a 9% 2-year forward revenue CAGR on the business, Insperity should be able to grow free cash flow at a rate of around 9% within the next two years (assuming free cash flow margins stay flat), adding credence to the point that this growth rate implied by current share prices is cheap in relation to the business’ future outlook.
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