More Regulations Mean More Business For Outsourcers
Calvin Coolidge once said the business of America is business. The outsourcing industry embraces that maxim, providing talent and services to handle nuts-and-bolts tasks of operations and employment, freeing up companies to focus on their core missions.
The industry has seen steady growth since its origin in the 1980s.
It currently employs between 2 million and 3 million Americans in what it calls co-employment situations with professional employer organizations. Nearly 250,000 businesses use employees contracted from PEOs.
Cintas, a Cincinnati-based outsource services company, built a stronghold in the uniform business before leveraging its relationships and… View Enlarged Image
The average PEO has grown more than 20% per year for each of the last six years, according to the National Association of Professional Employer Organizations, a PEO trade group.
As the global economy becomes increasingly competitive, many companies trim payrolls and operations in order to focus on core tasks. The kinds of outsourced services range from such tasks as supplying the uniforms used in high-demand settings, like hospitals and other health-care providers, to managing employee benefits and payrolls.
The rollout of ObamaCare — centralized health care under the Affordable Care Act — has created additional opportunities by adding layers of complexity and new regulations for businesses to manage.
For example, TriNet (NYSE:TNET) of San Leandro, Calif., is based in the cloud, administering payroll and health insurance services as well as advising companies on risk reduction. Its cloud services include expense reporting, time-tracking and travel policy management.
Its shares have more than doubled since its initial public offering in March 2014.
Sensing the growing importance of this industry, Congress stepped in last year and passed the Small Business Efficiency Act. This changed U.S. tax law to give official federal recognition to PEOs and streamline the taxpaying process for employers. One provision allows PEOs to collect and remit federal employment taxes, and it excuses their customers from liability for those taxes. The law goes into effect on Jan. 1, 2016.
In addition, the expansion of technology, including cloud computing, has led to the increasing desire among businesses to have someone else take care of ordinary business functions while they focus on bread-and-butter matters.
On Friday, the 24-stock Commercial Services-Outsourcing group ranked 25th out of the 197 industry groups monitored by IBD.
1. Business
The outsourcing sector has devoted itself to taking care of ancillary tasks to let other companies focus on their core pursuits.
Kingwood, Texas-based Insperity (NYSE:NSP) provides small- and midsize businesses human resources services, including health insurance, compliance with regulations, workers’ compensation, and employee benefits and training.
The company has targeted the white-collar sector — which brings bigger paychecks and lower risk of workplace-related accidents. They’ve also boosted their sales force by more than 300 employees and were more cost-effective in other areas of the business.
“They’re like a Cadillac,” James MacDonald, an analyst at First Analysis Securities Corp., said. “They really give you lots of service.”
Five consecutive quarters of earnings-per-share declines — and flat year-over-year share price growth in 2014 — led Insperity to become the target of activist investors at Starboard Value LP and Stadium Capital.
But EPS jumped 46% in Q4 and the company is expected to grow earnings by 56% this year. Shares have surged by more than 53% since Jan. 1. As companies either renew or change their health insurance plans at the beginning of each year, annual results may vary.
“In this PEO business you sell a lot of business on Jan. 1 and you lose a lot of business on Jan. 1,” MacDonald said.
2. Market
Employers endure a myriad of laws pertaining to their businesses and employees. Enterprising PEOs respond by diversifying their services.
The growing U.S. economy, now six years into a plodding economic recovery, has helped Cintas Corp. (NASDAQ:CTAS), but so has the company’s urge to diversify. Its shares grew by a robust 32% last year, far outperforming the overall Standard & Poor’s 500 index. In 2015, its shares are up by 55% so far, once again outperforming the S&P.
The Cincinnati-based company has expanded from its bread-and-butter uniform supply operations to providing fire extinguishers and protection, and first-aid products such as external defibrillator programs.
Cintas has posted 17 straight quarters of EPS growth, notching double-digit growth during the last five quarters.
“The company has been terrific about capitalizing on those other services,” said Elliott Schlang, an analyst at Great Lakes Review. “Once they got into the industrial doors, it was relatively easy but imaginative of them to say, ‘By the way, maybe you need some alarms for the factory floor.’ ”
3. Climate
The sometimes intrusive hand of the government into private enterprise generally is frowned upon in the business community. But the Obama administration’s push to increase the amount of rules governing businesses has created a growing client base for PEOs.
“One big-picture thing for the industry — the more complex the regulation, the better it is for these guys,” said MacDonald of First Analysis Securities. “This last administration … has been a gold mine for the PEO industry. Especially ObamaCare — it’s been a disaster from a company’s point of view.”
Another big shift is not political, but structural — employers seeking to grow, but hurt by health care costs that exceed the rate of inflation, push more costs and responsibility for benefits onto their employees. The creation of high-deductible health insurance plans is one example of that.
“As we shift in the U.S. from defined health care benefits to consumer-directed, (the outsourcers) benefit,” said Tobey Sommer, an analyst at SunTrust Robinson Humphrey. “We’re all going to increasingly have these kinds of accounts.”
4. Technology
As employers shift more cost and responsibility for managing benefits to employees, providing those benefits on a user-friendly platform has become increasing popular.
San Mateo, Calif.-based WageWorks (NYSE:WAGE) provides such programs as flexible spending accounts, health reimbursement arrangements and health savings accounts. It also provides such commuter benefits as parking and transit programs, including the delivery of debit cards and monthly commuter pass cards to customers’ homes.
Last year, local government efforts to reduce air pollution in the San Francisco Bay Area helped spur the company to act more aggressively to help local workers cut down on their bus and rail commuting expenses by between 25% and 40%.
However, WageWorks primarily handles the administration of health savings accounts and the like, which have grown in usage over the last decade — especially after the passage of the ACA.
“They’ve done a fantastic job in building a product that is very usable and friendly to employers who contract for it and employees who use it,” said Steven Wardell, an analyst at Leerink Partners.
5. Outlook
More regulations equal more work for PEOs, and the federal recognition under the Internal Revenue Code that kicks in next year should further solidify the industry. Increased regulations can be onerous for businesses, but one business’s headache is another’s windfall.
• Upside: The continuing complexity of regulation will keep driving up corporate costs and result in businesses looking to cut expenses by outsourcing the administration of employee benefits. Also, the trend of employees having more hands-on management of their health insurance benefits will likely result in more business for PEOs.
• Risks: PEOs’ health insurance business could suffer if employers push more of their workers toward health care exchanges set up under the Affordable Care Act. The industry also is cyclical, meaning that an improving economy will boost business as the unemployment rate drops. But it’s vulnerable to recession and the inevitable layoffs that ensue.
BY CIARAN MCEVOY, INVESTOR’S BUSINESS DAILY
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