For years, the story was stellar growth rates in Europe and Asia. But now, growth overseas has collapsed and margins are being squeezed at leading UK recruitment companies. Another round of broker downgrades looms and share prices in the sector are heading back down to year lows. When recovery comes, they'll bounce back very quickly, but most think things will get worse before they get better.
"I think you'll get them cheaper," says Henry Carver, head of support services research at Peel Hunt. One simple reason for that is the macroeconomic picture, which is getting worse not better. Speaking recently in Japan, Christine Lagarde, managing director of the IMF, warned: "Over the past few months, the outlook has, regrettably, become more worrisome". Ms Lagarde said the IMF plans to cut its global growth forecast of 3.5 per cent. She noted that while Japan and the Asia region had coped with the crisis well so far, contributing more than half of global growth since 2008, "this does not mean that Asia is immune. The spillovers from Europe are increasingly visible there".
That remark will have sent a chill down the spine of those recruiters who've touted Asian exposure as a key differentiator. Strong growth across Europe and Asia has more than made up for anaemic growth in the UK. Those days are over, though. The engine room of the Asian economy and the world's second-largest economy, China, is struggling. The HSBC Services Purchasing Managers' Index (PMI) showed activity growth had eased to near stagnation in June. The People's Bank of China responded by cutting rates for the second time this year; they are beginning to look rattled.
These fears were confirmed in Robert Walters' disappointing second-quarter trading update. Group net fee income (NFI) fell 3 per cent year on year, compared with 11 per cent growth in the first quarter, and the greatest weakness was seen in Europe and Asia Pacific, with NFI down 6 per cent and 5 per cent, respectively. David O'Brien, an analyst at Shore Capital, suggested there will be downgrades to Michael Page and Hays following their updates. Mr O'Brien has been taking no prisoners with his recent comments, saying: "We expect shares to drift in the short term and think Michael Page shares in particular are exposed at current levels."
Robert Walters' update is a red flag for the rest of the sector. The weakness in the Asia Pacific region was put down to a slowing banking and financial sector, and increased competition compressing margins. In the latest full-year accounts, Robert Walters had the greatest exposure to the region, with 51 per cent of NFI generated in Asia Pacific, but it is by no means alone. Michael Page generates 19 per cent of NFI from Asia Pacific, Hays 31 per cent of NFI, and SThree around 13 per cent through its rest-of-the-world (RoW) exposure.
Growth going backwards is not the only problem, either; the Asia Pacific region is relatively new to the recruitment model and as such has enjoyed margins well ahead of those in more mature markets. As competition increases those margins are being squeezed, which means recruiters are being hit with a double whammy of softening demand and tighter margins. This is a problem when you look back to the latest batch of full-year results from the sector's big players - around three-quarters of Robert Walters group operating profits come from Asia Pacific, two-thirds of Hays' and a third of Page's.
| Company | Ticker | Market cap | Current price | Current PE | Trough PE | Dividend yield | NFI geographic exposure** | |||
|---|---|---|---|---|---|---|---|---|---|---|
| £bn | (p) | Jul 12 | Oct 08 | % | EMEA | UK & Ireland | Asia Pacific | Rest of the World | ||
% | ||||||||||
| Michael Page | MPI | 1.11 | 364 | 19.5 | 4.7 | 2.74 | 43 | 23 | 19 | 15 |
| Hays | HAS | 1.01 | 72.9 | 13.0 | 4.4 | 6.56* | 33 | 36 | 31*** | |
| SThree | STHR | 0.33 | 271 | 16.1 | 4.4 | 5.16 | 50 | 37 | 13 | |
| Robert Walters | RWA | 0.15 | 196 | 13.9 | 3.7 | 2.63 | 26 | 26 | 51 | 2 |
*Historic figures dividend cut by 55 per cent on 22 Feb 2012 **Based on latest full-year results ***Asia Pacific and RoW combined | ||||||||||
UK woes
The UK market has been a difficult place for the recruitment sector since the credit crunch and it shows no signs of improving soon. "A real worry for me is the acceleration in the pace of decline, which suggests this isn't a mere blip," said Bernard Brown, partner at KPMG, when the June report from the Recruitment and Employment Confederation and KPMG was released. It painted a dismal picture as both permanent and temporary appointments declined at the sharpest rates since July 2009 while wages and salaries - upon which fee income is based - stagnated.
The Office of National Statistics added little cheer when it showed that between February and April of this year the total number of people without jobs fell by 51,000 to 2.61m, leaving the unemployment rate unchanged from the previous quarter at 8.2 per cent. The worry is that most of these people have simply given up trying to find work - tellingly, those claiming benefits is up 96,300 on a year ago at around 1.6m.
Michael Page issued its second-quarter update which showed that group NFI was only 1.6 per cent ahead of the first quarter and 6.6 per cent down year on year. The UK, responsible for 22 per cent of NFI, is struggling; it was down 9.2 per cent year on year. The most worrying thing for Page, though, was the slump in Continental Europe, Middle East and Africa, responsible for 42 per cent of group NFI. The region was down 4.4 per cent on the first quarter and 10.1 per cent year on year.
IC VIEW
Recruiters' shares may be approaching 52-week lows but the sector is facing another round of downgrades and the trading outlook is deteriorating across Europe and Asia, alongside an already lacklustre UK market. High operational gearing means margins are vulnerable to falling fee income.
But the same works in reverse - when fee income recovers, profits will shoot up - and recruitment shares are early-cyclicals that are quick to recover once the economy gathers steam. Our chart and table above show the troughs in the recruiters' ratings and share prices, and gives you an idea how much more they need to fall before becoming compelling.
A 'known unknown' to consider is government and central bank stimulus. Any concerted action here may well drive a rally in cyclical shares like recruiters.
Favourites
There is little to love in this sector at the moment but small-cap recruiter Staffline remains a solid buy. It is set to benefit from the government's initiatives to get the long-term unemployed back to work and has enjoyed strong demand for blue-collar workers in the UK automotive industry. The shares are up around 40 per cent from the start of the year but still only trade on 7.4 times forecast earnings, an unfair discount to the 14 times sub-sector average. Another survivor is engineering and technical recruitment company Matchtech; its shares are flat this year, but its blue-chip clients provide steady earnings and a chunky dividend, yielding around 7.6 per cent, keeps you company while you wait for a recovery.
Outsiders
Michael Page, Hays, Robert Walters and SThree are facing a horrible dilemma - a tough UK market with a slowdown overseas. Right now they have cash on their balance sheets and managed to maintain dividends through the last downturn, but the longer the recession lasts the more they will be tested. Trough ratings approaching the 2008 lows look unlikely (see chart above) as the market fell off a cliff back then. But, given we are bumping along the bottom, they need to come back a bit more before you jump in.
