Valuations for recruitment companies have risen considerably since the final quarter of 2014 - and with good reason. Investors have woken up to the renewed business confidence that is driving profits in the recruitment industry domestically. And while it's no secret that UK recruiters have been steadily expanding their footprints in emerging economies, they are also applying years of homegrown expertise to exploit mature labour markets. This dual approach has increased opportunities for recruiters, as they adapt to the changing needs of employers both home and abroad.
The German labour market provides a case in point. Strict labour laws, combined with limitations on the amount of personal data that can be held by companies, have historically hindered the development of a dynamic recruitment industry. However, Hays (HAS) has identified the German recruitment market as a core profit driver for the near term. The country accounted for more than half of net fee income for Hays' continental Europe business in 2014, but permanent placements are taking a back seat; around 90 per cent of Hays' net fee income in Germany is generated through temporary contracts.
Management hopes to grow operating profits in Germany to at least £85m by 2018. One way the company hopes to achieve this is by taking advantage of recruitment outsourcing by German employers, which chief financial officer Paul Venables said is growing year on year. Given fee income for its German business grew 6 per cent to £62m during the 2014 financial year, the target looks achievable. Contract hires have also risen across continental Europe, with net fees growing 13 per cent as employers look to increase flexibility in their workforces. The recruiter will continue to roll out its contractor model across continental Europe, taking advantage of reforms to strict labour laws in France and Germany. 1
Germany's recruitment market has become a lucrative destination for industry rival Michael Page International (MPI). Following tough trading conditions in continental Europe during 2013, its EMEA business returned to growth during the first half of last year. The German market put on a particularly impressive showing, increasing profits by 14 per cent year on year.
An improved US economic outlook has fuelled expansion on the other side of the Atlantic for global recruiters. In December, Hays announced the acquisition of US-based IT staffing business Veredus, which effectively doubled its presence in the country. Michael Page has recently expanded its US footprint. Indeed, it was the group's strongest market in the final quarter of 2014, with gross profits up a fifth on the previous year.
Within the Asia Pacific region, increasing demand for bilingual candidates by multinational companies has made Japan a prime target for growth opportunities. Robert Walters (RWA), like rivals Hays and Page, is targeting growth in the region. With two offices already established in Japan, management has said the business has the potential to become its fastest growing and largest segment within the group. Chief operating officer Giles Daubeney said demand for candidates with both fluent English and Japanese is such that the business can earn fees equivalent to 30-40 per cent of a candidate's first-year salary, compared with a rate of 20-25 per cent in the UK. Hays now has about 130 consultants in Japan; however, there is scope for much greater expansion. Mr Venables said if the business had the same level of penetration as the UK, it would employ about 2,000 to 3,000 staff. The group has identified the business as a 'future material profit driver' within the next five years.
However, the recruiters are not taking a uniform approach in Japan. Michael Page is pursuing a more localised strategy by winning clients among homegrown Japanese businesses. It has about 100 consultants based in the country - but that could rise significantly once the business is entrenched. Chief executive Steve Ingham said that there are big opportunities for global recruiters that focus on the local market, rather than simply targeting multinational clients. After all, "the reality is that [the multinational catchment] has a finite size, it's actually a small proportion of the Japanese economy," according to Mr Ingham.
However, some emerging economies have proved less fertile ground for growth. Faltering GDP, together with high inflation and interest rates have made trading tough for recruiters in Brazil. Robert Walters opened its first Brazilian office in São Paulo in 2010. Mr Daubeney admits the recruiter entered the market at the wrong time and the group has scaled back the number of consultants it employs in its four offices. The difficulties were confirmed by Mr Venables, who said that Hays' Brazilian business is currently falling short of expectations. As a result, the group has reduced headcount by 30 per cent since the third quarter of 2013. However, Michael Page did enjoy something of a recovery in its Brazilian business during the final quarter of last year, with gross profits up 16 per cent on the previous year - whether that improvement is maintained remains to be seen.
One of the other Bric economies also provides cause for concern. Despite its rapidly growing middle class, expansion in India has been rather slower than some might have predicted several years ago. Hays and Michael Page both have a presence in India, but there is still a question mark over whether the smaller fee margins will enable recruitment firms to derive sufficient profit to make expansion worth their while. Yet other emerging recruitment economies have certainly started to bear fruit. Management at Robert Walters credit the group's expansion into new frontier markets - including Thailand and Vietnam - as a reason why Asia Pacific net fee income increased by 42 per cent during the first half of the year. Meanwhile, in Latin America there are significant opportunities outside Brazil. Michael Page attributed The steep rise in Latin American gross profit during the final quarter of 2014 to the strong performance of its businesses in Colombia and Mexico.
IC view: The highly-cyclical recruitment industry has benefited from renewed confidence in the UK and a much-improved US jobs market. Most of the recruiters have experienced a slowdown in Australia and New Zealand, thanks to weak commodity markets. However, there is plenty of growth to come from expansion in emerging economies, despite near-term macroeconomic challenges.
Favourites
Michael Page International enjoyed strong growth in its US and UK businesses during the fourth quarter of last year, which make up more than a third of the group's gross profit. Net fee income for the group also grew 13 per cent to £136m during the fourth quarter, marginally ahead of expectations. The shares are trading on around 24 times 2015's forecast earnings. However, investors willing to take a longer-term view should not be scared off by the pricey rating. The group's conversion rate (a measure of how much Page's fee income is being converted into profit) improved by 1.2 percentage points to 13.5 per cent in 2014. However, this is still less than half the 32.1 per cent it achieved before the credit crunch. This indicates plenty more upside to come. Buy.
Robert Walters has enjoyed nine consecutive quarters of net fee income growth, borne out by three profit upgrades in 2014. Accordingly, analysts at Numis have increased full-year fee income estimates by 10 per cent for the 2014 year-end and 7 per cent for 2015. Again the shares carry a pricey rating, trading on around 23 times 2015's forecast earnings. Yet at the half-year stage, Walters was converting just 5.3 per cent of net fee income into operating profit compared with more than 20 per cent before the credit crunch. Buy.
Outsiders
Hays is by no means a poorly performing company, but it is our least preferred option among the recruiters. Its shares have risen 38 per cent since they began their recovery at the start of the final quarter of 2014. The shares are now trading at 160p. Analysts at Numis have set a target price of 184p but have moved to an 'add' rating rather than a 'buy'. The shares are also approaching seven-year highs, and are trading at, or near, historic earnings multiples, which indicates that much of the upside has already been priced in. Hold.
