First Advantage Feels Effects Of Hiring Downturn (NASDAQ:FA)

A Quick Take On First Advantage

First Advantage Corporation (NASDAQ:FA) reported its Q1 2023 financial results on May 10, 2023, beating revenue and matching EPS consensus estimates.

The firm provides background check screening software and related services to organizations.

Until we see negative hiring trends reverse, I’m Neutral [Hold] on First Advantage, although the stock is worth putting on a watch list.

First Advantage Overview

Atlanta, Georgia-based First Advantage Corporation was founded to develop a platform to provide employee/vendor background screening services via dozens of human capital management software integrations and other means.

Management is headed by Chief Executive Officer Scott Staples, who has been with the firm since April 2017 and was previously co-founder of Mindtree, an IT services firm.

The company’s primary offerings include:

• Criminal Background Checks

• Drug / Health Screening

• Extended Workforce Screening

• Biometrics & Identity

• Education / Work Verifications

• Resident Screening

• Fleet / Driver Compliance

• Executive Screening

• Data Analytics

• Continuous Monitoring

• Social Media Monitoring

• Hiring Tax Incentives.

First Advantage’s Market & Competition

According to a 2021 market research report by The Insight Partners, the global employment screening market, one of the firm’s focus areas, was an estimated $4.2 billion in 2020 and is forecast to reach $6.4 billion by 2028.

This represents a forecast CAGR of 5.5% from 2021 to 2028.

The main drivers for this expected growth are increased populations in urban areas resulting in greater job opportunities and employee demand.

Also, the number of applicants for each job opening has increased along with a larger number of contract & temporary workers.

Major competitive or other industry participants include:

• Accurate Background

• AuthBridge Research Services Private Limited

• A-Check America

• DataFlow Group

• Capita

• HireRight

• Pinkerton Consulting & Investigations, Inc.

• Sterling Talent Solutions

• Triton Inc.

• Verity Screening Solutions

• GoodHire

• Insperity.

First Advantage’s Recent Financial Trends

• Total revenue by quarter has declined in the most recent quarter:

• Gross profit margin by quarter has trended lower in recent quarters:

• Selling, G&A expenses as a percentage of total revenue by quarter have varied within a tight range:

• Operating income by quarter dropped materially in the most recent quarter:

• Operating leverage by quarter has remained positive, as the chart shows below:

• Earnings per share (Diluted) fell sharply in Q1 2023:

(All data in the above charts is GAAP.)

In the past 12 months, FA’s stock price has risen 0.93% vs. that of Sterling Check’s (STER) drop of 13.6%, as the chart indicates below:

For the balance sheet, the firm ended the quarter with $411.1 million in cash, equivalents, short-term investments and trading asset securities and $558.5 million in total debt, of which $1.4 million was categorized as the current portion due within 12 months.

Over the trailing twelve months, free cash flow was an impressive $206.5 million, of which capital expenditures accounted for only $3.3 million. The company paid $8.1 million in stock-based compensation in the last four quarters, a fairly low figure.

Valuation And Other Metrics For First Advantage

Below is a table of relevant capitalization and valuation figures for the company:

Click to enlarge

(Source – Seeking Alpha.)

Below is an estimated DCF (Discounted Cash Flow) analysis of the firm’s projected growth and earnings:

Assuming generous DCF parameters, the firm’s shares would be valued at approximately $12.73 versus the current price of $14.16, indicating they are potentially currently fully valued, with the given earnings, growth, and discount rate assumptions of the DCF.

As another reference, a relevant partial public comparable would be Sterling Check Corp.; shown below is a comparison of their primary valuation metrics:

Click to enlarge

(Source – Seeking Alpha.)

Commentary On First Advantage

In its last earnings call (Source – Seeking Alpha), covering Q1 2023’s results, management highlighted the “ongoing uncertainty from the economic environment that began to impact hiring demand in late November 2022.”

Since then, all major operating metrics for the firm have deteriorated, although the stock price hasn’t changed much, especially in comparison to competitor Sterling Check’s stock drop since late 2022.

Certain verticals such as healthcare and transportation have been resilient with stable hiring demand, while other verticals have shown varying degrees of weakness.

Notably, the company’s international business has been negatively impacted by its Indian customers who are exposed to BPO and IT service-related businesses, which have been reducing headcount substantially.

The company’s gross retention rate was 97%, with a customer base that is “strong, broad-based and continues to expand.”

Total revenue for Q1 2023 declined 7.6% year-over-year and gross profit margin decreased by 1.1 percentage points.

Selling, G&A expenses as a percentage of revenue increased by 0.7 percentage points and operating income decreased by 27.5% year-over-year.

Looking ahead, management guided full-year 2023 revenue growth to be negative (2.5%) at the midpoint of the range YoY.

Organic adjusted EBITDA is expected to be $247.5 million at the midpoint of the range, or negative (1.0%) versus 2022’s results.

The company’s financial position is fairly strong, with substantial liquidity, a meaningful long-term debt but very strong free cash flow; its net debt-to-EBITDA multiple is 0.6x, a reasonably low figure.

From management’s most recent earnings call, I prepared a chart showing the frequency of key terms mentioned (or not) in the call, as shown below:

I’m most interested in the frequency of potentially negative terms, so management or analyst questions cited “Uncertain” once, “Challeng[es][ing]” four times, and “Macro” nine times.

The negative terms refer to the current negative macroeconomic conditions affecting the firm’s international customer base which filter through to reduced revenue.

My discounted cash flow calculation indicates that First Advantage Corporation stock is fully valued at its present level and assuming a 5% annual growth rate, a generous assumption given its current likely 2023 contraction.

Until we see currently negative hiring trends begin to reverse, I’m Neutral [Hold] on First Advantage Corporation, although the stock is worth putting on a watch list.