Kenexa Needs to Best Competition

Kenexa Corporation (KNXA - Analyst Report) reported a solid second quarter, with revenue in line with our estimates and a lower-than-expected tax rate helped deliver upside to our EPS estimate. 

Although we do believe that economic uncertainty is responsible for some slowing, KNXA’s chief rival, Taleo (TLEO - Snapshot Report), reported strong results. We would not be buyers of the stock until KNXA demonstrates that it can outperform its peers. We therefore reiterate our Hold rating and $20 price target.

After a 40% sell-off following Kenexa’s Q3 2007 earnings release, the stock price has been flat, trading in the $18 to $20 price range. The company is trading at 12.9x our 2008 EPS estimates of $1.45, a discount to all but one of its competitors. Although the share price is well below 2007 highs, we are concerned that disappointments are not over given questions about the economy and job market.

We do believe that KNXA shares should trade at a discount to better positioned companies, such as Taleo, which we view as the industry leader. We therefore maintain our six-month price target of $20.00, which results in a P/E of 13.8x 2008 estimates, close to the industry median. On a P/S basis, KNXA is trading at 1.8x our 2008 revenue estimate, a small premium to the industry mean and median.

Kenexa’s ROE has been falling since it became public in 2005. Although the large drop in 2005 is related to the IPO, estimated declines for 2006 onwards is a result of declines in all three measures. Most concerning of these is the drop in net margin from 2006 to 2007. Moreover, an ROE in the low double digits is relatively low for a software company.

Read the full analyst report on KNXA