Recruiters have been a smart place to put your money over the last 12 months as they have raced ahead of the wider market on hopes of a cyclical upswing. The question investors must ask now is are those hopes realistic, and even if they are, is it too late to join the party?
Party on, says Numis Securities. The broker believes that confidence has returned to the staffing market and the focus will now switch to just how high earnings can go in an upswing. A return to peak productivity will lead to significant earnings upside, it believes, and valuing the recruiters on these potential peak cycle earnings implies further share price gains.
From boom to bust… and back again
History shows the recruitment sector to be incredibly cyclical. It bombed out in 2009 as hiring in the UK and Continental Europe ground to a halt and net fee income slumped. At the time, Hays' chief executive Alistair Cox described trading conditions as "the most challenging on record". There was a mini recovery in 2010-11, driven by growth in Asia Pacific and the Australian mining boom. But the wheels came off when Asia's financial sector caught Europe's cold and a dip in China's appetite for raw materials hit the Australian resources job market.
The current excitement stems from signs that the UK and Continental Europe are recovering. The International Monetary Fund recently upgraded its UK economic growth forecast for this year to 1.4 per cent from 0.9 per cent. And the better economic backdrop appears to be feeding into the job market. According to the latest survey by the Recruitment and Employment Confederation (REC) and KPMG, job vacancies in September grew at a similar pace to August, which was the fastest for over six years.
A more positive tone
The recent trading update from Hays (HAS), whose geographic spread makes it a good bellwether, gave credence to this more encouraging backdrop. Hays said it was seeing "improving" market conditions in many parts of the business. Jefferies analyst Kean Marden noted the more positive tone: "Market conditions have improved from 'fragile' six months ago to 'mixed' in July to 'improving' currently." UK net fee income rose 8 per cent year-on-year in the quarter ended 30 September - this time last year it was down 9 per cent. The recruiter said the UK recovery was broad-based, with eight of its 12 UK regions delivering year-on-year growth.
Continental Europe net fee income was up 13 per cent, with Germany seeing a 7 per cent increase, and net fees in Asia rose 17 per cent. Robert Walters (RWA) echoed the recovery theme, too. UK net fee income jumped 21 per cent, driven by strength in the regions and the recruiter's resource process outsourcing (RPO) business (where a company engages a third party to manage recruitment). Asia Pacific growth was double-digit, with the exception of Australia where conditions remain tough.
Some of the smaller, niche players have also cheered the market recently. Blue-collar recruiter Staffline's (STAF) first-half earnings per share rose 35 per cent, and Matchtech (MTEC), which specialises in hiring engineers, has just reported a 28 per cent jump in full-year operating profit.
But there are still soft spots
It hasn't been quite so upbeat for everyone. Michael Page (MPI) grew UK net fee income by 5 per cent in the third quarter - the best quarterly growth rate since June 2011. But management has warned that it only expects to make a full-year operating profit of £68m, almost £3m less than it predicted back in August. Finance director Andrew Bracey's surprise decision to quit just days before the news has only made matters worse and the shares have tumbled.
Page's focus on the slower-to-recover permanent market is partly to blame. The company's fortunes have also traditionally been seen as closely linked to the City jobs market, which remains subdued with banks and candidates equally cautious. According to financial services recruitment firm Astbury Marsden, 4 per cent fewer City jobs were created in September than a year ago. Hiring to support a pick up in IPOs and M&A has largely been offset by regulatory and economic pressure to downsize other parts of investment banks, it says.
Recruiters with a technology sector focus also hit a soft spot earlier this year. Profit fell at SThree (STHR), Harvey Nash (HVN) and Aim-listed Networkers International (NWKI) during the first half, although it is worth noting that all three have since indicated that the outlook is improving.
| Company | Ticker | Price (p) | Price Change 1 Year (%) | Market Value (£m) | CAGR EPS 2013-15 (%)* | Forward Dividend Yield (%)* | Forward PE* |
| Hays | HAS | 118 | 54 | 1630 | 27 | 2.4 | 20.6 |
| Harvey Nash | HVN | 90 | 47 | 66 | 16 | 3.5 | 10.7 |
| Matchtech | MTEC | 483 | 113 | 118 | 10 | 3.3 | 15.7 |
| Michael page | MPI | 487 | 36 | 1480 | 31 | 2.1 | 31.9 |
| Networkers Intl | NWKI | 45 | 28 | 37 | 2 | 3.1 | 9.6 |
| Robert Walters | RWA | 310 | 58 | 236 | 41 | 1.7 | 39.1 |
| Staffline | STAF | 645 | 161 | 163 | 12 | 1.4 | 15.9 |
| SThree | STHR | 356 | 26 | 432 | 35 | 3.9 | 30.0 |
| Average | 65 | 22 | 2.7 | 21.7 | |||
| FTSE All-Share | 13 | ||||||
| *Based on consensus forecasts from Thomson One Analytics | |||||||
The bear case
So are these weaker segments just late to join the party, or an indication that the cyclical upswing is based on weak foundations? These fears are mirrored in the debate on the wider economy, with lingering concerns over the fragility of the eurozone recovery and impact of the US government shutdown. If recovery in Europe and the US stalls, there would be a knock-on effect on Asian recruitment markets, and the cyclical recruiters would find themselves, once again, heading into a downswing.
Bears point to risks arising from structural changes in the recruitment market, too. Networking sites such as LinkedIn and job boards such as totaljobs.com allow candidates and companies to cut out the middleman. Add to that the growing role of RPO in the recruitment sector, which some argue can cannibalise the traditional agency business, and you can make a case for a structural margin decline. Bulls, however, still argue that RPO can exist profitably alongside a traditional agency business, and that firms will continue to prefer the candidate screening, tailored shortlist and due diligence provided by established recruitment companies.
IC VIEW:
Every recruiter has comfortably outperformed the FTSE All-Share over the last 12 months (see table). And in a sign that the market has done a pretty good job of pricing in growth expectations, the three most expensive stocks based on forward earnings multiples - Robert Walters, Michael Page and SThree - are also the three that currently have the highest forecast compound earnings growth.
On balance, the economic indicators, job market data and trading comments from the recruiters themselves indicate that the earnings outlook is better than it has been for some time. But given the recent outperformance of the sector, do not assume that a rising tide will lift all boats. Investors must consider who is best placed to meet those earnings expectations and who can still offer some valuation upside or yield protection - earnings disappointment will spell huge trouble. And, for the smaller players who demonstrate quality earnings, there's a great opportunity to re-rate and plug the gap between them and the big guys. And as Michael Page recently demonstrated, bigger does not always reduce the risk of disappointment.
| FAVOURITES: |
| Recent buy tip Staffline (590p, 10 Oct 2013) has the potential to grow earnings by more than the market currently expects, and its rating is well below larger peers. Harvey Nash (Buy, 90p, 27 Sep 2013) is the second cheapest stock on forward PE basis with an attractive dividend yield, too, despite forecasts for strong earnings growth. We like Matchtech's (Buy, 503p, 15 Oct 2013) attractive niche market position and decent dividend yield, and upgrade Hays to buy from hold on valuation grounds - its forward PE is just below the sector average despite ranking among the most optimistic in the sector and with forecast earnings growth way above the peer average. |
BROKER'S VIEW:
Underlying end markets are improving as client and candidate confidence increases. This can be seen in stable to rising (or decreasing more slowly) vacancy rates in major markets and we expect that gross profit growth will, on average, rise from 1 per cent in 2013 to 10 per cent in 2014. We do not think current consensus estimates reflect the operational leverage that the staffers will produce.
Higher volumes, greater productivity and, eventually, rising wages combined with cost reduction should drive 40-55 per cent conversion of incremental gross profit into earnings before interest, tax and amortisation (EBITA) over the next two calendar years. Historically, consensus has significantly under-estimated growth and operational leverage, both up and down.
Earnings momentum (net upgrades versus downgrades) is still, in aggregate, in negative territory for the professional staffers. We expect that as growth returns and operational leverage generates strong profit growth, momentum will turn positive. Historically this has supported rising multiples and share prices. We still see potential upside despite decent year-to-date share price performance
The staffing agencies have performed well. Shares are up 34 per cent on average so far this year and 30 per cent since the end of June. We think, however, that there is further scope for performance driven by re-rating. In times of recovery, two year forward multiples for the staffers have risen well above median levels as the stocks anticipate earnings momentum.
We rate SThree, Robert Walters and Hays as 'outperform'. We think that momentum at SThree will improve significantly into 2014 as the UK and German markets strengthen. As end-markets regain momentum, we expect Robert Walters to generate very strong operational leverage leading to rapid de-rating of forward multiples. We expect that both the UK and Germany can add £27m to Hays' EBITA over the next two years.
Andy Grobler is an analyst at Credit Suisse
