Why you should add this small ASX tech stock to your portfolio
If I told you we were going to have a global pandemic, that it was going have devastating impacts on millions of peoples' health, and that it was going to cause massive dislocations and wreak havoc on the global economy, but that we would also snap back to record low unemployment, you probably wouldn't believe me!
Forget the bull market in stocks, there's a bull market in employment going on - right now!
The number of people quitting their old jobs with the confidence they can move on to greener pastures is indeed surging. The Great Resignation, as many labour market experts have labelled it, has seen the number of workers in the USA who voluntarily chose to leave their job jump to record highs.
This surprising upshot of the global COVID-19 pandemic has created a substantial and unique opportunity for one small ASX-listed technology company that is at the forefront of the global surge in new hiring.
Anyone who has been through the process of hiring a worker knows just how cumbersome this process can be, not to mention how many different organisations you'll need to contact to get all the information you require. Xref (XF1) describes itself as a human resources company, but its main business is facilitating various employment checks essential to modern-day hiring.
These often include the usual reference checks, identity, police and working with children checks, but increasingly, employers are also wanting to know about a potential employee's social media activity.
All of this information can be sourced quickly via Xref's fully automated candidate referencing platform. The platform allows employers to request any number of these important checks in minutes, and also to receive fast and accurate response data. With respect to Xref's automated reference checking service, which contributes approximately two-thirds of its revenue, responses are often received within 24-hours. Xref's service is so good and so efficient, that they are now used as the go-to for pre-employment verification by some of the world's most Blue-chip companies - think MacDonald's, Woolworths, Crown Resorts, NSW Government, and many more.
Xref's platform is cloud based, so it can accessed from anywhere, and it's designed to be integrated with the systems of large human resources and recruitment companies. The platform has been highly reviewed, and is targeting a massive addressable market: think potentially every person that's ever going to be hired. With respect to this last statement, Xref's potential becomes even more exciting when you consider they are expanding into North America (around 11% of revenue in FY21) and Europe (around 7% of revenue in FY21). These contributions appear set to continue to grow. In its first-quarter of FY22 (Q1FY22) update, Xref reported that revenues from North America increased by an impressive 83%.
Growth is certainly the main attraction for potential Xref investors. The company grew its sales by 38% in FY21, but since then, has reported 126% growth in Q1FY22 sales, and 71% growth in second-quarter FY22 sales. It has crossed the all-important operating cash flow positive threshold, that is, its business is generating surplus cash that can be used to fund further growth in the business, or potentially down the track, be returned to shareholders by way of dividends.
The operating cash flow surplus for Q2FY22 was $0.2 million and cash reserves as at December 31, 2021, were $10.5 million. We also note that the operating cash surplus for the first half of FY22 is $1.4 million compared to a $1.2 million deficit in the first half of FY21. Xref has now achieved three consecutive quarters of positive operating cash flow and has traded profitably for the full 2021 calendar year. Add to this, the company has no bank debt.
So, Xref appears to be in a strong and improving financial position. Indeed we expect it to report its maiden net profit after tax (net of grants and subsidies) this financial year. But, whilst growth in sales and earnings is fantastic, as investors, we want to also know that we are also getting value. On this point, we can say that Xref is presently trading at around 60 times our forecast FY22 earnings. This might sound a little exxy, but the growth in the business is going to bring this down very quickly.
Our belief is that you're paying more like 35 times FY23 earnings and as little as 20 times FY24 earnings. The latter is certainly starting to look very cheap for a growth stock. Of course, there's execution risk between now and the realisation of those future earnings to consider. But on this item, we feel that our estimates are conservative enough, and that the tailwinds for Xref are sufficient enough, to label its execution risk as "Low".
The final point we'll make on Xref's fundamentals, is that the business remains founder led, and he also happens to be the company's major shareholder. Lee-Martin Seymour, Xref's Co-founder and CEO, owns around 17% of the business. This is a major tick for us. It's the best way to align management's and shareholders' interests. Mr Seymour and his team have a substantial track record of disciplined and strategic capital allocation and, most importantly for small companies like Xref, of strict cost management.
Whilst the short-to-medium term goal for Xref is to continue to build on its success as a simple, cost effective and efficient solution in an area that is anything but, in the longer term, the business has aspirations to transition into a more holistic human resources information technology business, serving the entire hire to retire journey. The journey so far has been impressive, and we expect similar success in the future.
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