A Member of Pat McKeough’s Inner Circle recently asked for his advice on a company that offers human resources consulting and outsourcing services.
Pat likes the firm’s recurring revenue model and rising earnings despite COVID-19 difficulties. However, he notes a lot of that growth has been through large acquisitions, which might prove harder to integrate than the company expects.
Q: Pat, may I have your recommendation on whether Morneau Shepell is a buy right now? Thank you.
Morneau Shepell Inc. (Symbol MSI; www.morneaushepell.com), is the largest Canadian firm providing human resource consulting and outsourcing services. The company aims to help employers manage pensions and benefits, health and disability programs, and workplace training and education.
Morneau Shepell has 6,000 employees in offices across North America. It offers services to over 24,000 organizations in Canada, the U.S. and 160 other countries worldwide. The company’s systems are used to administer benefits, pensions and savings plans, and to maintain records for approximately 8.5 million plan members. This includes maintaining 175 administration websites for clients and hosting their sites. It also provides all support and transaction services on behalf of its clients.
Before its conversion from an income trust to a conventional corporation in January 2011, the company operated under the name Morneau Sobeco Income Fund.
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Former federal finance Minister Bill Morneau was the executive chair of Morneau Shepell (which was founded by his father) until October 2015. Mr. Morneau quit that position in October 2015, when he entered politics. He continued to hold shares in the company until November 2017. That’s when he sold all his shares in Morneau Shepell, in response to conflict-of-interest criticism.
In July 2018, Morneau Shepell completed its big acquisition of LifeWorks Corp. for $435 million. LifeWorks is an employee wellness business that operates in the U.S., Canada, Australia and the U.K. Its employee assistance program offers wellness programs that feature perks and savings, as well as rewards and recognition.
In August 2019, Morneau Shepell purchased Mercer’s U.S. health and pension plan administration business. The price was $58 million U.S. The acquisition expands the company’s presence south of the border and strengthens its competitive position. It brought with it 70 corporate clients (representing 2 million participants) and now generates 12% of Morneau Shepell’s annual revenue.
Morneau Shepell also acquired U.S.-based MorningStar Health in September 2019. This acquisition enhanced its presence in the growing U.S. niche of absence management (leaves of absence, disability, absence reporting and accommodations). As a well-established company, MorningStar Health also has in-depth knowledge of U.S. regulations and markets.
Inner Circle: Earnings continue to rise but goodwill and intangibles are high
Due in large part to its acquisitions, the company’s total annual revenue over the last five years has risen 56.7%, from $567.3 million in 2015 to $888.9 million in 2019.
Earnings also jumped 58.3%, from $16.4 million ($0.33 a share) in 2015 to $26.0 million ($0.49) in 2016. (Note that the jump in part reflects a $10.7 million, one-time writedown in 2015.) Earnings then rose 27.0% in 2017, to $33.0 million ($0.62), mostly due to higher revenue from acquisitions. Earnings then fell 34.0% in 2018, to $21.8 million ($0.36). That was due to $19.7 million (after tax) in one-time expenses related to the LifeWorks acquisition. Profit then fell 13.0% in 2019, to $19.0 million ($0.29). The decline came mostly from costs related to the Mercer acquisition, as well as a change in accounting rules.
In the three months ended June 30, 2020, Morneau Shepell’s revenue jumped 15.8%, to $246.2 million from $212.7 million a year earlier. The gain came in part from the Mercer acquisition.
Earnings increased 20%, to $8.3 million, or $0.12 a share, from $6.3 million, or $0.10. The higher revenue drove the gain, along with the company’s success in integrating its LifeWorks and MorningStar Health acquisitions.
Morneau Shepell’s long-term debt of $424.2 million (as of June 30, 2020) is a low 19.5% of its market cap. However, due to the company’s aggressive growth-by-acquisition strategy, its goodwill and intangible assets now total $1.1 billion, or a high 51% of its market cap. While Morneau Shepell has so far been able to successfully integrate its acquisitions, that might not continue, especially with purchases as big as LifeWorks. If an acquisition of that size sours, a significant writedown of the company’s goodwill or intangibles could hurt its earnings and share price.
The ongoing pandemic also adds uncertainty to the corporate environment that Morneau Shepell operates in. Customers may postpone adding the company’s services until their outlooks become clearer. However, the company’s high level of recurring revenue and its stable earnings add to its appeal. The stock offers investors a 2.5% yield.
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