Stockwatch: The top stock in this cyclical sector

Is it too late in the cycle to hold recruitment stocks, or is this sector a prime “momentum”play for 2018? Moreover, should a bigger international stock be preferred over a smaller one, lest any economic shocks do materialise?

Thus, a comparison is invited of Hays (HAS), capitalised at £2.8 billion in the Mid-250 index (MCX), with Robert Walters (RWA), capitalised at £465 million in the Small-Cap index. In the last three years, Walters’ momentum has been greater – underlying earnings growth of 35% to 75%, versus the mid to high teens for Hays – and Walters’ capital growth of 146% since the Brexit sell-off in June 2016 compares with 106% for Hays.

Yet, with Walters’ chart looking a tad rich in the short term and Hays doubling its dividend payout – thus adding a material yield of 3.7% to the value equation – this looks better support than the 1.9% yield for Walters.

Hays now offering better overall risk/reward

Broadly, if you are bullish on the global economy then favour Walters as the smaller more operationally geared business; but if you are wary that 2018 won’t be shock-free, then Hays may offer better risk/reward.

In past years I’ve drawn attention to both: Walters variously from 177p in January 2012 when it was more a contrarian play, amid global macro fears at the time despite bullish underlying progress; and Hays, more lately since April 2017 at 168p.

Both stocks have reflected on/off sentiment towards recruiters: Hays drifting from 194p early last October to 175p in December; but has just rebounded to a fresh high of 195p after a trading update in respect of this period cites a 13% like-for-like growth in net fee income – led by the international businesses, which now represent 76% of group net fees.

Walters has been doing even better with overall net fee income up 19% over this period; both companies benefiting from strong growth in Continental Europe, up 17% for Hays and 28% for Walters which is also doing better than Hays with respect to North America and “other international markets”, up 108% versus 16% for Hays. Although the Mid-250 stock being nearly six times larger than the small cap makes very high growth rates relatively difficult.

Both companies affirm bullish equity strategists

Such recruiter updates affirm 2018 optimism where economists note virtually all countries enjoying some extent of growth, most especially Continental Europe, as if this vindicates central banks’ stimulus in the major economies, now rippling out.

The European Central Bank (ECB) has taken the most radical measures with negative interest rates even, besides QE. Hays’ exposure to Continental Europe is probably near 50% of group net fee income (the guesstimate due to including “rest of world” in this segment) versus 25% for Walters, which is a positive for Hays’ “reward” profile, if tricky to judge how the “risk” aspect may pan out if the UK does not achieve a trade deal with the EU – to include services.

As January negotiations get underway it appears Germany, at least, insists the UK should continue paying into the EU budget to get an agreement including services, thus the possibility of a goods-only trade agreement (and where that would leave UK service firms?) or a reversion to World Trade Organisation rules.

Mind that both Hays’ and Walters’ prosperity in Europe likely reflects past years’ extent of freedom of movement of people, the Brexit vote countered. As with plenty of other British firms operating in the EU, it’s not a risk the stockmarket presently appears to (want to) recognise, but is one that can yet complicate things for recruiters. For Hays, in particular, its stock has to climb this wall of worry, while also benefiting from near-50% exposure to Continental momentum.

Asia Pacific also performing very well

Hays’ chief executive declares: “We continue to see strong trading conditions in the vast majority of our international markets…we are well-positioned to capitalise on the many clear growth opportunities we currently see in most of our markets, while maximising earnings and cash along the way.”

Asia, for example, is up 16% for Hays, but only 6% for Walters; Hays enjoying 14% growth in Australia albeit 24% elsewhere in Asia with Japan up 19%, China 25%, Hong Kong 51% and Malaysia 76%.

This really is worth noting in terms of the wider upshot for equities – recruitment trends often being a leading economic indicator – at a time when most attention is on the US economy, as to what real effect of Republican party tax cuts and a flattening yield curve pointing at recession risks.

Hays’ progress also appears broad-based with construction, accounting & finance and office support all doing well, likewise permanent and temporary employment. Altogether it’s a vindication of current high hopes in stockmarkets.

Meanwhile, the UK & Ireland – about one quarter of net fee income – were up just 1% as 4% private sector growth (74% of this division’s fees) was offset by an 8% fall in public sector markets. Public sector IT and education markets were down 5% and 6% respectively, and generally the Midlands was the one problem area down 7%. Again, this is interesting in wider UK economic context; is a recruiter flagging higher risks e.g. for public sector subcontracting?

Bear in mind also, Hays’ international profile is a virtue while sterling trades adversely with respect to Brexit negotiations, and the Bank of England maintains monetary stimulus. But if negotiations involve more give-and-take towards the eleventh hour, and/or inflation prompts interest rates higher than expected, sterling will strengthen to make Hays’ like-for-like growth rates more challenging. Overall, it looks wise to be hedged against sterling and the UK economy; though events can yet surprise.

Dividends to become the more critical support factor?

Hays hasn’t guided profits “materially higher” like Walters did last 12 December, and on simple comparisons of price/earnings (PE) versus earnings growth, Hays is quite pricey: PE multiples in the mid to high teens versus growth rates in the low teens for the current year to end-June and the 2018/19 year.

Yet Walters’ 39% earnings growth for 2017 is so far expected to drop below 10% in 2018, making its stock expensive at 616p on this – admittedly snapshot – basis, given the PE-to-growth (PEG) ratio jumps from an attractive 0.4 to pricey 1.6 times.

Meanwhile, Hays’ dividend payout expectation has more than doubled from a consensus 3.1p per share in respect of the current year to end-June, to 7.2p based on upgrades last autumn, thereby raising the yield to 3.7% at 195p per share. (The table’s showing a slip in 2019 consensus to 6.2p relates to Numis looking for just 3.9p versus Investec on 9.3p, both independent brokers).

Hays – financial summary           Consensus estimates year ended 30 Jun 2013 2014 2015 2016 2017 2018 2019                 Turnover (£ million) 3,697 3,678 3,843 4,231 5,081     IFRS3 pre-tax profit (£m) 118 132 156 173 205     Normalised pre-tax profit (£m) 118 133 156 173 204 231 256 Operating margin (%) 3.4 3.8 4.2 4.2 4.1     IFRS3 earnings/share (p) 5.1 6.0 7.3 8.4 9.5     Normalised earnings/share (p) 5.1 6.2 7.4 8.4 9.5 10.8 12.0 Earnings per share growth (%) -6.4 20.3 19.6 13.6 13.6 13.4 11.6 Price/earnings multiple (x)         19.5 17.2 15.4 Price/earnings-to-growth (x)         1.4 1.3 1.3 Historic annual average P/E (x) 19.2 24.0 23.0 16.3 18.8 19.0   Cash flow/share (p) 5.0 6.7 9.0 7.0 9.2     Capex/share (p) 0.8 0.8 0.9 1.1 1.5     Dividend per share (p) 2.5 2.5 2.7 2.8 3.0 7.2 6.2 Dividend yield (%)         1.6 3.9 3.4 Covered by earnings (x) 2.1 2.5 2.8 3.0 3.3 1.5 1.9 Net tangible assets per share (p) -0.4 2.4 2.9 15.1 23.9                     Source: Company REFS              

This is well-justified by Hays’ strongly cash generative profile versus scant capital expenditure needs (see 2017 cash flow per share of 9.2p versus capex of 1.5p, in the table), thus, it being quite overdue to reduce dividend cover from over 3 times below 2.

Walters remains more cautious, retaining cover over 3.5 times though compares with only about 1.5 times in 2012/13; its eponymous chief executive being inherently cautious as to earnings visibility in the industry.

Overall, it looks like Hays’ better liquidity than Walters could start to tempt more institutions, especially if confidence grows in the dividend re-rating, meaning its stock should be less vulnerable to downside in case of shocks.

I’d pay attention to this break-out with an all-time high of 195p, especially as a means for UK investors to play global growth. Hays’ valuation looks up with events, but the strong narrative and dividend bode well for 2018. Accumulate.


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