Profits are surging at this high yield recovery play

Gattaca (GATC:105p), a specialist science, technology, engineering and mathematics (STEM) recruitment business, flagged its forecast-beating results in a pre-close trading update in August.

The outperformance has been driven by self-help measures which have seen the cost base rationalised, low-margin legacy business exited, the UK property portfolio slimmed down from five to three offices, and a keener focus on working capital management. So, although net fee income (NFI) dipped from £44.2mn to £43.4mn, profitability surged, so much so that underlying pre-tax profit rose eightfold to £2.6mn as the conversion rate of NFI to operating profit rocketed.

The group’s relatively new management team has also succeeded in improving cash collection and payment terms, hence why group days outstanding improved from 54 to 46 days, in turn slashing trade receivables and accrued income balances by £8mn. This was the primary reason why net cash surged from £12.3mn to £21.6mn, a sum that accounts for two-thirds of Gattaca’s market capitalisation of £33.5mn. The improved profit performance also benefited from net finance income of £0.3mn.

Key to the transformation has been a change in culture within the organisation which has not only reduced staff attrition rates (from 40 to 33 per cent), but improved sales productivity. NFI per recruiter increased 7.8 per cent to £125,100 in the 12 months to 31 July 2023 and, with the benefit of further efficiency gains and improved standards, the key metric could rise 6 per cent in the new financial year, predict analysts at Equity Development.

Although total NFI dipped slightly due to lower permanent recruitment fees (26 per cent of NFI), there was a noticeable outperformance by the group’s two largest categories: defence and infrastructure. The segments delivered 8.8 per cent growth in NFI to account for 51 per cent of the total. Political instability is driving demand for the former, while UK infrastructure projects are increasing the need for white-collar workers.

STEM focus offers defensive qualities

Macroeconomic headwinds introduce uncertainty over the timing of the UK economic recovery and are having implications for recruiters and permanent roles. The UK market accounts for 95 per cent of group income, so sensibly Gattaca is increasing its exposure to contract placements to mitigate the impact of a decrease in permanent recruitment. Directors also note that the STEM markets are recovering to their pre-pandemic levels so this focus on STEM skills in well-defined markets should insulate the group from any significant swings in demand. The board was certainly confident enough to declare a 5p a share annual dividend alongside the results.

For the new financial year, analysts at Equity Development are modelling for a £2.2mn increase in NFI to £45.6mn, more than a third of the increase is expected to be delivered by the restructured international division. On this basis, expect adjusted pre-tax profit to increase from £2.6mn to £2.8mn, but earnings per share (EPS) to surge from 4.5p to 6.5p with the benefit of a lower tax charge. Adjust for net cash per share of 67p, and the shares are rated on a forward price/earnings ratio of 5.8, a low multiple for an ongoing recovery play that will benefit from additional efficiency gains in the year ahead. The dividend yield of 4.8 per cent and EPS accretive share buybacks are supportive of the share price, too.

I suggested buying the shares, at 74p, in my 2023 Bargain Share Portfolio, reiterated that advice at 81p (‘Profits are booming at this cash-rich recruiter’, IC, 30 March 2023), and at 105p at the pre-close trading update (‘There's more to come from this resilient recruiter’, IC, 17 August 2023). Rated slightly above book value parity, and on a modest multiple of 4.5 times forecast operating profit to enterprise valuation, the shares are still worth buying.