HireRight Holdings Stock: A First Take (NYSE:HRT)

“The reason that man is seldom satisfied with his salary is that when it increases, he increases his expenses.” – Mokokoma Mokhonoana

Today, we take an in-depth look at a small-cap name in an interesting niche of the market for the first time. The stock has started to rally lately but is still down some 30% YTD in 2022. The company has a strong backlog and has seen some recent insider buying from a beneficial owner as well. An analysis follows below.

Company Overview:

HireRight Holdings Corporation (NYSE:HRT) is a Nashville, Tennessee based provider of workforce risk management and compliance solutions, offering background checks, verification, and health screening services to ~39,000 clients in over 200 countries around the world. The company screened over 29 million job applicants and processed over 110 million screens in 2021. HireRight was founded in 1990, grew significantly in size when in merged with background screener General Information Services in 2018, and went public in October 2021, raising net proceeds of $393.5 million at $19 per share. The stock trades at around $11.50 a share, translating to an approximate market cap of $900 million.

Services:

The company provides criminal record checks, employment and education verifications, driving background checks, health screenings, alcohol and drug tests, identity services, credit record searches, and a battery of business services to four core verticals (transportation, technology, healthcare, and financial services), which contribute just under 60% of its revenue. HireRight is a market leader, boasting approximately half of the Fortune 100 as clients. Globally, it competes with the likes of First Advantage (FA) and Sterling Talent Solutions in a screening market estimated at ~$4.2 billion in 2020. It also competes with mid-tier providers including Accurate, Certiphi, and Cisive. Its backgroundchecks.com platform competes with instant online screening solution providers – i.e., servicers to small businesses – such as Checkr and Asurint.

Strategy:

HireRight is looking to further its total addressable market by expanding into skills assessments and credentialling, reference checks, enterprise risk services, and biometric screening. The company’s targeted verticals for growth include domestic financial services and the gig economy. It is also looking to broaden its international reach, which currently comprises 8% of its topline.

Further down the income statement, management has embarked on a series of technology initiatives that will automate many back-office processes; thus reducing its manual data reconciliation practices, which will generate substantial cost savings. Launched at the beginning of FY22, this project is expected to improve its operating margin by ~500 basis points by YE24.

Historical Operating Performance:

Its growth plans notwithstanding, as a mature operator with a substantial client list, HireRight’s prospects are largely a function of hiring prospects at its largest clients, which is somewhat subject to worldwide economic activity. The company generated Adj. EBITDA of $146.1 million on revenue of $647.6 million in FY19, followed by Adj. EBITDA of $92.9 million on revenue of $540.2 million in FY20, as hiring was curtailed during the pandemic. Buoyed by an extremely healthy demand for labor as the world returned to work, HireRight delivered FY21 Adj. EBITDA of $160.2 million on revenue of $730.1 million, representing 35% growth at the topline. As the FY21 results were being reported, management foresaw a continuation of this momentum into FY22, projecting non-GAAP earnings of $1.39 a share and Adj. EBITDA of $185 million on revenue of $812.5 million (based on range midpoints), representing improvements over FY21 of 12%, 15%, and 11%, respectively.

Share Price Performance:

And to a large extent, HireRight had more than delivered on its promises, besting consensus estimates and upwardly revising its outlook as part of its first two earnings reports of FY22. The outlook exiting 2Q22 was non-GAAP earnings of $1.70 a share and Adj. EBITDA of $193.5 million on revenue of $825 million, then representing increases of 37%, 21%, and 13% (respectively) as the company began delivering on its margin improvement initiatives while its business remained robust. However, the market was largely unimpressed, viewing its growth as unsustainable against the worsening macroeconomic backdrop. Despite its underpromising and overdelivering during 1H21, HireRight’s stock never rose above its IPO price at any time during 2022, peaking at $18.66 a share (intraday) on August 15, 2022.

3Q22 Earnings & Revised Outlook:

As it turned out, the market’s skepticism was eventually well-founded. On November 3rd, 2022, the company reported earnings of $1.40 a share (non-GAAP) and Adj. EBITDA of $54.0 million on revenue of $210.3 million versus $0.53 a share (non-GAAP) and Adj. EBITDA of $51.6 million on revenue of $205.0 million. The bottom line was helped demonstrably by a tax allowance reversal that improved results $0.88 a share, rendering ‘adjusted’ non-GAAP earnings $0.52 a share, still representing a solid beat over Street expectations of $0.46 a share. Adj. EBITDA margins in the quarter improved 48 basis points year-over-year to 25.7% and 157 basis points year-to-date over the same period in 2021 to 23.7%.

Owing to the tax allowance reversal, management raised its FY22 non-GAAP earnings outlook from $1.70 a share to $2.55 a share. However, it was compelled to lower its FY22 Adj. EBITDA forecast from $193.5 million to $181.5 million and its topline estimate from $825 million to $801.5 million – all based on range midpoints. This surprising backtrack (especially considering HireRight’s 3Q22 revenue was more or less in line with expectations) was a function of a broad-based slowdown in hiring at existing customers (~$15 million), the cancellation of an employment verification contract at one of its largest clients – “due to a substantial price increase at one of (HireRight’s) suppliers” – worth ~$6 million per quarter in 2H22 – and currency headwinds (~$2 million). That said, YTD net retention was 117% and HireRight added 44 new logos in the quarter, further characterizing its pipeline as “very, very strong”.

The market’s response was swift. Already down 31% since mid-August, shares of HRT cratered 37% to $7.99 in the subsequent trading session.

Balance Sheet & Analyst Commentary:

The response was a bit head-scratching from a balance sheet perspective, as the company generated free cash flow of $57.8 million in the first nine months of FY22 versus only $9.1 million in the prior-year period. As such, it was able to lower its leverage in the span of one year from 7.1 to 2.9, holding unrestricted cash and equivalents of $147 million against debt of $702 million.

Management agreed that the market had overreacted, announcing a $100 million share repurchase program on November 14, 2022, sparking a 23% one-day (and 51% two-week) rally that has morphed into a near full recovery from the severe selloff of November 4th.

The Street’s response to HireRight’s revised FY22 outlook was also noteworthy, with two analysts downgrading the stock from outperform to hold, while a total of six analysts downwardly revised price targets. In total, the Street now has four buy and three outperform ratings versus four holds with a median price target of $13.00 a share. On average, they expect the company to earn $1.28 a share (non-GAAP) on revenue of $750.9 million in FY23, representing 23% and 6% decreases versus FY22 (respectively), if one backs out the tax reversal from management’s FY22 forecast.

Private equity shop General Atlantic, who initially invested in General Information Services back in 2017 and became an owner of HireRight through the 2018 merger, has used the weakness since the 3Q22 earnings release as an opportunity to cost average, adding over 1.1 million shares to its ownership interest, which now totals approximately 40%.

Verdict:

Trading for a forward PE of under nine and a price-to-sales on FY23E revenue of roughly 1.2, HireRight is not absurdly overvalued. However, with recently announced layoffs at Meta Platforms (META) and Amazon (AMZN), the market is going to have a hard time digesting management’s assessment of its own pipeline as “very, very strong“, especially in light of the fact that it just lowered its own FY22 outlook. The poor ADP Jobs report this morning was also hardly encouraging.

Furthermore, the large snapback rally since the announcement of the share repurchase program makes shares of HRT difficult to chase. That said, we would become more constructive on any pullback towards the $8 level.

“The crowning fortune of a man is to be born to some pursuit which finds him employment and happiness, whether it be to make baskets, or broadswords, or canals, or statues, or songs.” – Ralph Waldo Emerson