Walters still wobbly

There is agreement that, when a recovery comes in the recruitment sector, it will be temporary jobs that will be in demand. That's because employers tend to emerge from a recession in a fragile mood. They have fresh memories of financially and emotionally-fraught redundancy programmes and they are unsure that economic conditions will justify renewed expansion in the long term. That's bad news for recruiters that concentrate on placing permanent staff, such as Robert Walters, which generates 65 per cent of its fees from these activities. Indeed, while a shortage of candidates until late 2007 meant Walters rode a wave of rising demand and rising fees, this has now come crashing down. Indeed, in May management said that the year-on-year decline in net fee income had accelerated to 28 per cent in March and April, compared with a 21 per cent decline recorded in the previous two months. And some City analysts now predict that Walters will make a loss this year (see table).

Seen against this trading backdrop, the 85 per cent bounce in Walters' share price off its 12-month low looks silly. But it should not be dismissed out of hand. Indeed, as stockbroker Seymour Pierce points out, in past downturns shares in recruitment companies have started to recover between one and two years ahead of the return to gross domestic product (GDP) growth. And there are signs that economic conditions, while still deteriorating, may be close to the bottom. Indeed, for a couple of months, the recruitment industry’s own Report on Jobs, which is compiled by KPMG and the Recruitment and Employment Confederation, has noted a slowing decline in the number of permanent and temporary positions being made available.

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However, the surge in Walters' share price could be too much, too soon. After all, even if we are near the bottom, it is still unclear whether this recession will be V-shaped or U-shaped - that is, whether there will be a sharp bounce back or whether dull economic activity will persist. Certainly, few economists predict that unemployment will peak any time sooner than 2010 in the UK, where Walters generates about a third of its net fee income. What's more, the group's roots in financial and accountancy recruitment make it particularly vulnerable to the effects of this particular recession.

Management has responded to the sharp deterioration by cutting costs and has reduced its head count from 1,687 staff mid-way through last year to 1,336. Also good for shareholders is Walters' growing cash pile, which may protect the dividend. Recruiters tend to generate lots of cash as a downturn develops. That's because they pay the wages of temporary staff they have placed and wait for clients - ie, employers - to pay them back. But, as activity slows, more money comes in than goes out. As a result, Investec, another stockbroker, forecasts that net cash will stand at £26m by the year end, which is equivalent to almost a quarter of the current market value of Walters' shares.

Another positive factor is that Walters' geographic diversity could well put it in the right place to capitalise on an upturn. Against that, having offices in many different locations puts a limit on cost cutting; after all, staff numbers can be cut only so much in any one location before a recruiter effectively gives up its position.

But, despite the smattering of positives, the shares still look overvalued. Broker Charles Stanley points out that, when recruiters' shares were recovering during the previous downturn, valuations peaked at about 35 times expected earnings. Compare that with Robert Walter's rating now. While EPS are forecast to be negative this year, Investec has pencilled in an anaemic EPS of 0.7p for 2011 and just 2.6p as a recovery becomes more established in 2012. That puts the shares on a multiple of 199 times 2011's forecast earnings and 53 times for 2012's. True, earnings are likely to surge once a recovery sets in, but the timing of the recovery remains guesswork. In the meantime, shares in Hays, a recruiter with a large temporary staff placement arm, which is likely to be an early beneficiary of recovery, are trading at 15 times forecast EPS for the year to the end of June 2010. In comparison, Walters' shares look very expensive.