Description

COMPANY OVERVIEW (From Their Website):
Kelly Services is a Fortune 500 staffing services company headquartered in Troy, Mich., offering human resources solutions that include temporary services, staff leasing, outsourcing, vendor on-site and full-time placement. With more than 2,200 company owned and operated offices in 25 countries, Kelly provides to its customers 750,000 employees annually, with skills including office services, accounting, engineering, information technology, law, science, marketing, light industrial, education and health care. Sales in 2000 were $4.5 billion. The company is the third largest in the U.S. and the fourth largest in the world.

Segment breakout (first nine months of 2001): Commercial staffing (49% of sales, 66% of operating profit); Professional, Technical, and Staffing Alternatives (25%, 24%); and International (26%, 10%). Insiders own 48% of Class A stock and 92% of Class B stock.

TRACK RECORD
Although Kelly's stock has been stuck in a fairly narrow trading range for the past decade, its operating perforance has actually been quite strong. From an earnings trough of $1.02/share in 1991, the company moved its earnings up every year until 1999, when the company made $2.36/share. Earnings were slightly lower at $2.29/share in 2000 as the company began to feel the effects of the economic downturn and will plunge to an estimated $0.45 in 2001. Analysts are currently looking for a further decline slip to $0.44/share in '02, indicating they don't see any rebound potential this year.

From a return on equity perspective, the company was in double digits throughout the 1990's. ROE was 10.9% in 1991, rising to a peak of 15.8% in 1998. It fell down to 12.8% in 2000 and is expected to plunge to 3% in 2001.

CASH FLOW GENERATION
Kelly has historically generated substantial cash flow, as shown in the table below. Capital expenditures are not too high -- although technology expenses have increased over the years. The company does has some discretion in CAPX, as demonstrated by the decline in 2000

2000 1999 1998
Cash from Ops: 88,857 115,464 116,505
CAPX (54,237) (76,696) (59,089)
Cash - CAPX 34,620 38,768 57,416

During the first nine months of the year, the company's operating cash flow has actually increased despite the significantly lower earnings due to receivables payoffs.

THE DIVIDEND
A good portion of the comany's free cash over the past couple of years has gone to pay the company's hefty dividend ($35MM in 2000, $34MM in 1999). At the end of November, however, the company reduced its dividend by 60% to $0.10/qtr. This will bring the annual cost down to about $14MM/year.

While dividend cuts often portend horrible news, that may not be the case here. The company has a very solid balance sheet with no net debt, so the cut wasn't caused by balance sheet distress. Additionally, the company's stagnant stock price over the past decade combined with annual dividend increases (a 29 year tradition) had resulted in a juicy payout of over 4.5%. In today's marketplace, such a payout is too high for a firm that has growth opportunities. The reduced dividend still gives shareholders a 1.8% yield -- above that of the S&P 500.

COULD DIVIDEND CUT AND NEW PRESIDENT INDICATE CHANGES AFOOT?
Concurrent with the announcement of the dividend cut, Kelly announced that Carl Camden would assume the President title from CEO Terence Adderley. Camden joined the company in 1995 as VP of marketing and had been promoted to COO in March 2001. This promotion, combined with a dividend cut that will provide more financial flexibility, could indicate that the company will be managed somewhat more aggressively.

STRONG BALANCE SHEET
As mentioned previously, KELYA has an excellent balance sheet with no net debt. As of Sept. 30th, the company had $80MM in cash and $47MM in short-term debt. The company's book value is $611MM ($17.00/share) and is pretty solid -- intangibles represent $120MM (20%) of that value.

VERY ATTRACTIVE VALUATION
While Kelly looks expensive based on this year and next year's earnings estimates (~50x), those are depressed numbers. Using other metrics, the company looks quite attractive.

Kelly is currently trading at a price/sales ratio of 0.19, a level lower than at any point between 1976-1999 (during that period the range was 0.2x-1.05x with a median of 0.43x). (The stock's low point after the September attacks was a price/sales ratio of 0.14x.) Kelly also looks good relative to its major competitors. Robert Half is trading at 1.78x sales and Manpower is at 0.25x sales.

Switching over to price/book ratios, Kelly is at 1.3x book value (1.6x excluding intangibles). This is a lower valuation than the stock had at any point between 1976-2000 (range of 1.3x to 6.6x with a median of 2.5x). It also compares very favorably with its major competitors: Robert Half is currently trading at 6x book and Manpower is at 3.4x.

CONCLUSION
Kelly isn't completely out of the woods. A good portion of their business is with large corporations, which are cutting business and squeezing margins (think General Motors, a Kelly customer). In addition, overall demand will not necessarily rebound sharply at the beginning of a turnaround. Employment growth often lags an economic recovery and Kelly didn't start to bounce back from the '91-92 downturn until 1993.

That being said, the company's current valuation -- near 25 year lows based on price/sales and price/book -- discounts an enormous amount of bad news that will continue for quite some time. It's very unusual to find such an cheap valuation for a high quality company with a strong track record. Expectations are currently very low and could easily be exceeded if the company were to control costs a little better (which is starting to happen) or the economy stabilizes.

Assuming some stabilization in the economy and management focus on cost control, it seems quite conservative to think that Kelly can attain a 10% ROE in the next couple of years (this is lower than the level during the 1991-1992 recession and well below the 14%-16% company range between 1994-1999). Under such a scenario, the company would have net earnings of $60MM or $1.67/share -- 13.6x the current price.

While waiting for the turnaround to occur, the stock should have downside support from its strong balance sheet, $17 book value, and 1.8% dividend yield.

Catalyst

- Economic stabilization and/or cost cutting that lead to rising earnings estimates

- A rebound to more normalized level of profitability in the next couple of years

- More business-based decisions and less family control, as indicated by the recent dividend cut and Terance Adderly's decision to pass the President title to Carl Camden.

- Attractive valuation, excellent balance sheet, and a still decent dividend yield (1.8%)