Stockwatch: An AIM share to accumulate

In my end-April macro review I noted a latest Red Flag report from Begbies Traynor (BEG), the AIM-listed corporate recovery specialists, warning of “large increases in financial distress in Q1 2018” – especially in professional services, up 46%.

I said to be aware of this regarding various recruitment stocks I’ve covered, but take your cue from specific updates. Thus, it’s interesting to see an encouraging – if carefully worded – set of prelims from Harvey Nash (HVN), an AIM-listed global technology recruitment and outsourcing group, for its latest year to end-January.

At 102p, the stock trades on a modest 8.9 times, latest core earnings per share (EPS), falling to 7.4 for the current year’s forecast, yielding 4.4% prospectively. So, if the narrative is improving, upside is likely, with scope also to lock in a useful yield.

  • Are markets really heading for 30% crash?
  • Recruit Harvey Nash to your portfolio 

Fundamental re-rating or late-cycle boost to results?

Some 80% of gross profit derives from serving technology/digital markets thus an aspect of cyclicality regarding firms’ budgets to spend on tech.

Yet Harvey Nash claims 4 out of 10 firms are raising investment in digital, with skills’ shortages also driving up demand. Structural change – i.e. more automation and robotics – could mitigate adverse change in the wider economy, and this group’s one-stop shop approach to tech-recruitment across clients’ needs is claimed supportive through the business cycle.

Underlying figures re-rate group performance from a quite flat trend in recent years, also a volatile-sideways stock chart.

On 19 April, Numis Securities, an independent broker, had projected £10.6 million normalised pre-tax profit and there’s been a slight beat, to £10.8 million on revenue up 13.4% to £889 million.

Figures have benefited from acquiring a Swedish leadership consultancy and a UK IT solutions/recruitment firm, last July/September.

Harvey Nash’s chief executive proclaims “a transformational year” with “buoyant demand for technology skills, and a combination of organic and acquisitive growth – together with a renewed strategy and transformed cost base.

Analysts at Numis entertain £13.4 million profit in the current financial year i.e. about 20% earnings growth.

Sceptics might say this is what you’d expect a long economic upturn since 2009 and Harvey Nash has belatedly got its act together; yet that could be harsh.

Versus Begbies’ remoaning about the UK economy, Harvey Nash’s boss is “particularly delighted by the outstanding performance of the UK business against a backdrop of uncertainty and an overall decline in demand reported by many others in our sector.”

The group has seen higher demand in UK regions and strong growth linked to financial services in London.

“We are encouraged by the strong trading momentum in the second half-year which has continued into the current financial year and are confident of significant progress in the year ahead.”

Seemingly careful wording – “significant” – allows scope to tweak expectations, mind.

Inflection point for underlying progress and the stock

I’ve drawn attention to Harvey Nash as long ago as September 2009 at 36p, when its markets were improving but smaller recruiters’ shares were under a cloud of wary sentiment, also as a medium-term play on wider UK recovery.

But after a useful re-rating the chart has been volatile-sideways between roughly 55p and 125p, with a trough from late 2016 to early 2017.

The first half of last year then saw a rise from 60p to 102p as if the market was anticipating more definite improvement, albeit a drop to 75p last November/December. Now these results add grist, hence the rise to 102p with a 105p offer price hinting at break-out.

Admittedly, these results are mixed, though the bad bits link to “transformation”: a 37% drop in headline pre-tax profit due to office closures, net cash flow down from £15.1 million to £0.5 million due to higher working capital as trading increased, also £4.5 million costs of transformation and £8.0 million spent on acquisitions.

Underlining confidence, the total dividend still rises 5% to 4.3p – i.e. covered 4.3 times by “core” EPS, and putting aside temporary factors impacting cash flow, see from the table how the cash flow profile has been historically stronger than earnings, with modest capital spending needs as a “people business”.

The dividend therefore looks pretty secure to withstand bumps in the UK economy, supporting the stock’s risk/reward profile.

Source: interactive investor            Past performance is not a guide to future performance

Diversified from risks in the UK economy

Harvey Nash is also well-balanced geographically, with gross profit (the benchmark for an agency type business) sourced about 40% equally between the UK/Ireland and continental Europe, with the US representing about 14% of gross profit and Asia Pacific the remainder.

Demand in London has been mixed, reflecting the Begbies’ report, but the rest of the UK and Ireland are up over 18%.

Overall gross profit in Europe is up 5.4% albeit flat in constant currency, with strong performance in Netherlands/Belgium and good in the Nordics, offset by a period of restructure in central Europe which reduced fee earners.

Rest-of-world is also mixed, with strong results from remaining offices in Asia Pacific where the focus is on IT outsourcing from Vietnam and Australian recruitment.

The US being the world’s largest technology recruitment market, it is said to offer strong growth potential, however gross profit fell 16.4% to £13.9 million amid acute skills shortages on the West Coast, which reduced placements, although excluding the closure of a Denver office, US operating profit fell over 50%, thus performance here needs to improve.

Harvey Nash Group – financial summary           Estimates year ended 31 Jan 2014 2015 2016 2017 2018 2019               Turnover (£ million) 697 678 677 784 889   IFRS3 pre-tax profit (£m) 6.4 8.5 9.1 8.5 5.4   Normalised pre-tax profit (£m) 9.1 9.3 9.3 9.3 10.8 13.4 Operating margin (%) 1.4 1.5 1.5 1.2 0.7   IFRS3 earnings/share (p) 5.2 8.5 9.4 8.7 4.7   Normalised earnings/share (p) 8.9 9.5 9.7 9.8 11.5 13.7 Earnings per share growth (%) 3.3 7.6 2.0 0.2 17.3 19.1 Price/earnings multiple (x)         8.9 7.4 Price/earnings-to-growth (x)         0.5 0.4 Annual average historic P/E (x) 11.9 9.5 7.2 8.1 8.4   Cash flow/share (p) 6.4 9.2 16.8 19.8     Capex/share (p) 2.4 4.9 5.6 1.4     Dividend per share (p) 3.0 3.3 3.7 3.9 4.3 4.5 Yield (%)         4.2 4.4 Covered by earnings (x) 2.9 2.9 2.7 2.5 2.7 3.0 Net tangible assets per share (p) 20.5 18.0 4.7 9.5 -2.5  

Source: Company REFS            Past performance is not a guide to future performance

Looking overall attractive in the medium term

On positive view, revenue growth coincides with restructuring benefits that should help drive profits this financial year.

Dividing the price/earnings (PE) multiple by the earnings growth rate derives a highly attractive price/earnings-to-growth (PEG) ratio of 0.5, reducing to 0.4 this year (where sub-1.0 implies value) if the forecast is fair, although strictly you’d want to see a more established growth record as PEGs easily varied.

A worse-case scenario would be UK firms cutting technology spend amid Brexit realities, or a slowdown in Europe if falling money supply proves a forward indicator. Meanwhile, US challenges drag on.

Less so would be the results continuing an element of exceptional costs given a chief purpose of moving to AIM last July was “to facilitate future acquisitions to complement organic growth.”

At end-January net debt was £6.8 million versus net cash of £5.6 million in 2017 albeit relating to working capital needs.

Mind the balance sheet reflects a typical acquirer of people businesses, with intangible assets 103% of net assets, otherwise it is well-comprised to withstand a trading downturn.

Bid prospects in the near and longer term

If Harvey Nash has finally turned a corner, coinciding with a modest rating, it could be a useful bolt-on for a larger staffing group to achieve capital growth.

DBAY Advisors, an international investment manager in the Isle of Man and London, owns 26.1% and Miton Asset Management has 10.9%, thus while the chief executive owns a modest 1.1% of this £75 million company it’s wide open to a takeover.

Institutions that have held through volatility may quite easily accept say a 150p a share offer, representing an exit PE barely 11 times. That’s speculative but is worth bearing in mind as spice to the investment case. Accumulate.

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Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company’s or index name highlighted in the article.

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