Valuentum Exclusive Analysis for the Discerning Investor

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Image Shown: Korn Ferry posted record fee revenue and diluted EPS performance in the final quarter of fiscal 2021 as its business continued to recover. We include Korn Ferry as an idea in our Best Ideas Newsletter portfolio and continue to be huge fans of the name. Image Source: Korn Ferry – Fourth Quarter of Fiscal 2021 IR Earnings Presentation

By Callum Turcan

On June 22, the global organizational consulting firm Korn Ferry reported fourth quarter earnings for fiscal 2021 (period ended April 30, 2021) that beat both consensus top- and bottom-line estimates. Shares of KFY surged higher by almost 10% during the normal trading session on June 22 as management provided promising near-term guidance in conjunction with the earnings update. The ongoing economic recovery from the coronavirus (‘COVID-19’) pandemic in the US and elsewhere is having a powerful impact on Korn Ferry’s outlook, which is currently quite bright.

From January 12, 2021, when Korn Ferry was first added to the Best Ideas Newsletter portfolio (link here), to the end of the normal trading session on June 22, share of KFY are up ~49% while the S&P 500 (SPY) is up ~11% during this period (before taking dividend considerations into account). We are huge fans of Korn Ferry and continue to view the firm’s capital appreciation upside quite favorably. The top end of our fair value estimate range sits at $79 per share of Korn Ferry.

In conjunction with its latest earnings update, Korn Ferry boosted its dividend by 20% sequentially, bringing its quarterly payout up to $0.12 per share or $0.48 on an annualized basis. Shares of KFY yield ~0.7% on a forward-looking basis as of this writing. Please note that when Korn Ferry publishes its Fiscal 2021 Annual Report (10-K SEC filing) and after we roll our valuation model forward, we may adjust our fair value estimate higher.

Earnings Update 

During the fiscal fourth quarter, Korn Ferry’s GAAP revenues jumped 24% year-over-year as its fee revenue recovered from the pandemic-induced fall. The company’s strength in North America was key, and its international business is also starting to regain some steam according to management commentary provided during the firm’s latest earnings call. Management noted that Korn Ferry’s strength was widespread with every business line reporting growth. Fee revenue, which represents the lion’s share of Korn Ferry’s sales, hit at a record at $555 million last fiscal quarter (up 26% year-over-year and up 17% sequentially). Korn Ferry reported $1.21 in GAAP diluted EPS in the fiscal fourth quarter, another all-time high.

Image Shown: All of Korn Ferry’s business lines showed signs of significant improvement during the final quarter of fiscal 2021 as the company continues to recover from the COVID-19 pandemic. Image Source: Korn Ferry – Fourth Quarter of Fiscal 2021 IR Earnings Presentation

The firm’s GAAP operating income surged four-fold year-over-year last fiscal quarter due to a combination of revenue growth and cost containment measures embarked on in the wake of the COVID-19 pandemic. Leaning on its virtual delivery systems has also been key. More recently, Korn Ferry has been bulking up its consulting workforce to meet recovering demand as we covered in our June 21 pre-earnings note (link here). During Korn Ferry’s latest earnings call, management noted the firm continued to bulk up its consultant workforce in the fiscal fourth quarter.

Korn Ferry’s balance sheet remains pristine. At the end of April 2021, Korn Ferry had a net cash position of ~$702 million (inclusive of non-current marketable securities) with no short-term debt on the books. The company did not include a cash flow statement in its earnings press release, though Korn Ferry likely remained quite free cash flow positive in the final quarter of fiscal 2021 (after generating substantial free cash flows during the first three quarters of fiscal 2021 as we covered in our pre-earnings note).

When management was asked about Korn Ferry’s capital allocation priorities during the firm’s latest earnings call, the company stressed that it would be prudent when pursing M&A activities. Additionally, management alluded to the firm having the financial capacity to pursue a combination of share buybacks and dividend increases to reward investors going forward. Korn Ferry’s net cash position offers the firm multiple avenues for upside.

Guidance and Operational Updates

Looking ahead, Korn Ferry expects to post $535 million-$555 million in fee revenue (roughly on par with its performance during the final quarter of fiscal 2021) and $1.04 - $1.14 in diluted EPS in the first quarter of fiscal 2022. During Korn Ferry’s latest earnings call management noted that “we expect that new business in the first quarter will remain strong. We saw that in May, and so far, new business month-to-date in June is in line with our expectations” which we find very encouraging. Management also noted that Korn Ferry’s “new business in the fourth quarter was also a record and actually accelerated throughout the quarter, leaving us well positioned for growth in fiscal '22” during the earnings call.

Korn Ferry is optimistic that over time, the company will become more effective at cross-selling. Here is what Korn Ferry’s management team had to say on the issue during the firm’s latest earnings call (emphasis added):

“…[O]ur success driving cross line of business referrals continues to grow. Just over three years ago cross line of business fee revenue referrals were approximately 15%. Today, fee revenue from cross line of business referral stands at almost 27% for all of fiscal '21 and almost 29% for the fourth quarter.” --- Robert Rozek, Korn Ferry's Chief Financial Officer, Executive Vice President and Chief Corporate Officer

Part of Korn Ferry’s strategy on this front involves improvements in the firm’s ability to sell its offerings remotely over the past few years (its growing “inside sales” division) and part of this strategy involves recent improvements to its ability to deliver products and services digitally. Here is what management had to say in response to an analyst’s question on the topic of Korn Ferry’s potential cross-selling upside during the firm’s latest earnings call (emphasis added):

“Well, I think it's substantial. I mean, when you look overall. The encouraging thing is that you look at the company's top line and almost 30% is from inside sales, which tells you the strategy is working and its increased steadily over the last two to three years, quarter-on-quarter. So you look at it overall, and you say, it's at 29% and I think we've got substantial headroom. The thing that was -- actually the number may sound low, but the thing that was most encouraging to me this last quarter were the referrals into Executive Search and even though the number is 12%, that may sound low, that's up substantially from a couple of years ago when it was like it 3%, 4%, or 5%.

So that's an extra, call it, $50 million to $60 million of top line and so the company's strategy is to be the premier organizational consultancy. But for us, we have this intangible asset which is our Executive Search business and that allows us to take the relationships that we have at the top of the house and drive deeper impact with our clients. So, I think there is significant room to grow…” --- Korn Ferry's Chief Financial Officer, Executive Vice President and Chief Corporate Officer

Korn Ferry noted that it intends to bulk up its ‘Executive Search’ workforce as well as part of its broader talent growth ambitions during its latest earnings call, given how important that this business segment is to Korn Ferry’s financial performance. During the final quarter of fiscal 2021, this business segment generated ~36% of its revenues and ~37% of its non-GAAP adjusted EBITDA.

Image Shown: Korn Ferry’s Executive Search business segment represents a key source of fee revenues and profits while providing additional operational synergies. Image Source: Korn Ferry – Fourth Quarter of Fiscal 2021 IR Earnings Presentation

For reference, RPO stands for recruitment process outsourcing. Korn Ferry’s ‘RPO and Professional Search’ business segment generated a substantial amount of new business last fiscal quarter. The business segment’s profitability, measured by its non-GAAP adjusted EBITDA margin, surged from the final quarter of fiscal 2020 to the final quarter of fiscal 2021. During this period, Korn Ferry’s RPO and Professional Search segment saw its EBITDA margin grow by ~950 basis points, albeit off of a low base.

Image Shown: Korn Ferry’s RPO & Professional Search business segment has staged an impressive rebound of late, aided by significant new client gains. Image Source: Korn Ferry – Fourth Quarter of Fiscal 2021 IR Earnings Presentation

In the final quarter of fiscal 2021, Korn Ferry’s adjusted EBITDA margin hit 20.3% which is above the company’s long-term target, which is around the 17%-18% range. As Korn Ferry is now growing its core consulting workforce once again, the company’s adjusted EBITDA margin will face some headwinds going forward though the firm’s revenue growth outlook is quite bright due to the momentum the company had heading into fiscal 2022. Korn Ferry’s ‘Digital’ business segment is steadily growing, aided by rising subscription and license fee revenue. While a relatively small part of its business, subscription revenues provide for greater cash flow visibility which in turn creates stronger cash flow profiles.

Image Shown: Korn Ferry’s Digital business segment is quite lucrative and growing at a steady clip. We appreciate the resilience of this operation in the face of the COVID-19 pandemic. Image Source: Korn Ferry – Fourth Quarter of Fiscal 2021 IR Earnings Presentation

Management Commentary

One area Korn Ferry views as a source of strength is its customer base of large clients. For reference, Korn Ferry generated over $1.8 billion in fee revenue in fiscal 2021. Here is what management had to say on the issue during Korn Ferry’s latest earnings call (emphasis added):

“In a post-pandemic world and beyond, we're delivering an integrated value change, digitally enabled and delivered. To deliver this at scale, we're bringing everything together in a digital framework. All this makes our world-class IP even more relevant and unique. To fulfill our vision and position our company for long-term success, we remain relentlessly focused on meeting the evolving needs of our clients.

Number one, we're driving an integrated solutions based go-to-market approach through our marquee and regional accounts. That not only facilitates growth and enduring partnerships, but it's also key to more scalable and durable revenues. We have about 350 marquee and regional global accounts and they continue to demonstrate the power of the strategy. The accounts, they generated about $640 million in fee revenue during the year and sustainably utilize all of our global capabilities even during challenging economic periods.” --- Gary Burnison, CEO of Korn Ferry

Additionally (emphasis added, lightly edited):

“Our… marquee and regional account program, that [Korn Ferry’s CEO] talked about, really continues to add value, providing a steady strong growing stream of fee revenue for our firm. For all of fiscal year '21, 35.3% of our consolidated fee revenue was generated from these accounts. Further, our year-over-year fee revenue on marquee and regional accounts was essentially flat, while the rest of the company was down about 9%. For new business, our marquee and regional accounts were actually up 11% year-over-year, while the rest of the company was flat.” --- Korn Ferry's Chief Financial Officer, Executive Vice President and Chief Corporate Officer

Management recently noted Korn Ferry’s ‘Consulting’ business segment reported that “new business tied to large engagements, those over $500,000 in value was up approximately 56% in the fourth quarter and up approximately 31% for all of fiscal '21” with strength seen across its entire business, particularly in North America. On a final note, new business from Korn Ferry’s smaller clientele (engagements less than $500,000) was “up over 40%” in the final quarter of fiscal 2021 after being down 27% in the first quarter of fiscal 2021 according to recent management commentary. Korn Ferry’s strength was quite widespread, and we appreciate what that signals about the company’s future after a stellar fiscal fourth quarter earnings report.

Concluding Thoughts

We continue to be enormous fans of Korn Ferry and its capital appreciation upside potential. Part of the firm’s strength comes from its industrial clients representing approximately 25%-30% of Korn Ferry’s business (according to recent management commentary), keeping in mind industrial activity has rebounded strongly from the depths of the pandemic-induced downturn last calendar year. As the services side of the global economy starts to recover in earnest, Korn Ferry’s financials should continue to improve going forward, while management also sees room for additional upside from its industrial clients as well.

Korn Ferry also has ample room to improve its cross-selling abilities going forward, aided by its ability to deliver its services and products digitally. We like Korn Ferry as an idea in our Best Ideas Newsletter portfolio and are proud to have highlighted the name for our members back in January 2021 before shares of KFY really start to climb higher over the following months and to this day. The company’s dividend policy offers incremental upside to its capital appreciation potential.

Korn Ferry’s 16-page Stock Report (pdf) >>

Tickerized for KFY, ADP, DLX, EFX, JOBS, MAN, NSP, PAYX, RHI, HURN

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Callum Turcan does not own shares in any of the securities mentioned above. Apple Inc (AAPL), Cisco Systems Inc (CSCO) and Microsoft Corporation (MSFT) are all included in both Valuentum’s simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio. Alphabet Inc (GOOG) Class C shares, Facebook Inc (FB), Korn Ferry (KFY), PayPal Holdings Inc (PYPL) and Visa Inc (V) are all included in Valuentum’s simulated Best Ideas Newsletter portfolio. Oracle Corporation (ORCL) and Qualcomm Inc (QCOM) are both included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.