Recruiters have raced ahead of the market over the last four months as these highly cyclical stocks bounce on hints of a looming recovery. Markets around the world have been on a risk-on fuelled rally since the final quarter of 2012 as concerns over the fiscal cliff and the Chinese economy have eased. The question for investors now is whether the rally will be maintained and whether it is too late to enjoy the ride.
The good news is that analysts think there is still money to be made from the recruitment sector. David O'Brien, an analyst at broker Shore Capital, expects activity levels within the recruitment market to turn during 2013 and stronger growth into 2014. Despite share valuations looking a bit expensive after a strong run, he thinks there will be buying opportunities in the year ahead. With PE ratios as high as they currently are, the market appears to believe that forecast earnings are coming through and that there is the potential for upgrades as the sector delivers.
| Company | Ticker | Price | Price change YTD | Market Value | Dividend Yield | Current PE | Historic Average PE* |
| (p) | % | (£m) | % | ||||
| HAYS | HAS | 101 | 22.1% | 1406 | 2.49 | 19.6 | 18.3 |
| MICHAEL PAGE | MPI | 453 | 14.6% | 1377 | 2.21 | 33.3 | 28.2 |
| STHREE | STHR | 352 | 6.3% | 431 | 3.98 | 25 | 17.8 |
| ROBERT WALTERS | RWA | 214 | 10.9% | 164 | 2.41 | 31.5 | 18.9 |
| MATCHTECH GROUP | MTEC | 281 | 18.2% | 66 | 5.55 | 11.6 | 8.2 |
| HARVEY NASH GROUP | HVN | 72 | 14.5% | 53 | 3.82 | 8.5 | 16.2 |
*Simpe average over last 13 years Source: datastream | |||||||
Stop-start recovery
Recruitment shares have had a lumpy recovery since they hit their lows in 2009. The first stage was an almost unbroken run which started in early 2009. The key reason for this was strong growth in the Asia Pacific region driven by the financial centres in Singapore and Hong Kong and the antipodean mining boom in Australia. Then, in late 2011, growth in Asia started hitting the buffers as the cost-cutting contagion spread through the financial sector. This was followed by the unthinkable. The Australian mining sector started slowing down in 2012 as Chinese demand for raw materials cooled on lower growth expectations.
The Australian economy has become accustomed to growth, with the last recession a distant memory from 20 years ago. So the current mining sector slowdown has hit business confidence hard. Miners and other industries linked to the commodities sector have put recruitment plans on hold after such a strong unbroken run. "The prospect of the mildest of recessions has had a disproportionate effect on confidence in Australia after it has been cruising for so many years," says Henry Carver, an analyst with Peel Hunt.
Rapid response
Alastair Cox, chief executive of Hays, says that from September onwards there was a "marked slowdown" in the mining sector, particularly in permanent recruitment, as miners paused for breath from their expansion plans. Hays' half-year results, which were reported at the end of February, showed net fees in the Asia Pacific region down 11 per cent to £111.2m and operating profits slumped by a quarter to £36.3m. Mr Cox was not troubled, though. He said: "The trick to achieving profitability in this market is that you've got to be very quick to react and take out costs when you see markets coming down, but at the same time have the courage of your convictions to invest in those markets that feel more positive."
Hays certainly responded to the Australian slowdown quickly, with a 13 per cent reduction in staff levels. Overall in its first six months, Hays reduced headcount by 161 to 5,038, with the majority of those jobs coming out of the UK and Ireland. This helped Hays' half-year results beat market expectations, with pre-tax profits down 6 per cent on the prior period to £56.7m and net fee income down 4 per cent to £360m. The slowdown also meant Hays paused on its office opening schedule with no new sites opened in Asia Pacific or continental Europe, and five offices closed in the UK.
Mr Cox is confident that recruitment companies can navigate these tough economic conditions by adapting to employers' needs. "Employers are looking for more flexible workforces and cost bases." He says that employers unsure about the future are not replacing permanent staff who leave and are instead filling gaps with temps. Adapting to this structural shift in the market is protecting profitability. Hays reported that temp fees increased 4 per cent during the first six months and now contribute 59 per cent of group net fees. By contrast, fees from permanent recruitment were down 7 per cent on lower volumes.
Strength in diversity
It is not just the structure of the market that is contributing towards recruiters' resilience, it is their global and industry exposure, too. Hays is a good example of how this insulates profits from regional shocks. Asia Pacific may be slowing down, but growth continues in Germany. Net fees in continental Europe and the rest of the world were up 5 per cent to £140m, with operating profits up 29 per cent to £23.5m. The German business represents 54 per cent of net fees in the region and was driven by broad-based growth across contracting, temp and permanent placements in engineering and IT.
The UK, which has been a drag on results since the credit crunch, is also showing signs of life. Employers have been coaxed out of their shells as the big economic worries clear. The joint KPMG and Recruitment Employment Confederation (REC) report showed employer demand for staff increasing into December, with moderate increases in wages and salaries. UK unemployment fell in the three months to December by 14,000 to 2.5m, the Office of National Statistics said, while the number in work jumped by 154,000 to 29.7m. Hays' UK division returned to profit in the six months to 31 December after making a loss of £3.1m in the prior period. Mr Cox added that momentum was good in January and February with strong returns to work.
IC VIEW
Shares in the recruitment sector have raced ahead around 20 per cent on average since the beginning of December, well ahead of the FTSE 100 which is up around 8 per cent. As yet, earnings are still falling so investors are buying more in expectation of an improvement rather than on its delivery. The move has also been exaggerated by a wider risk-on rally as investors feel the worst has been avoided, if not entirely resolved. Recruiters are some of the most cyclical stocks in the market so their progress is understandable.
With share prices now extended in the expectation of an earnings recovery, this leaves the ratings somewhat exposed. Certainly, the valuations of Michael Page and Robert Walters shares look high, with both trading on 2013 forecast PE ratios of 27 times. Even Hays is on 21 times. This compares with a sub-sector 2013 forecast average of just over 19 times and a 10-year historical average of 15 times. The obvious problem is that if earnings progress is delayed then the downward adjustment could be very sharp.
The markets have certainly got off to a good start, but it looks like the recruiters are pricing in a trouble-free 2013. Given the underlying economic issues still present, it is highly likely we will get a correction at some point during this year. This would present a good opportunity to take part in any further recovery. In anticipation of this, we upgrade our recommendations on Hays and Michael Page to a hold.
