Interactive Investor

Stockwatch: is this 9% dividend yield too good to be true?

14th April 2022 10:00

Edmond Jackson from interactive investor

There’s plenty of uncertainty around at the moment, but prioritising shareholder returns has grabbed the attention of our stock picker, who puts this share on a prospective ‘buy’ list. 

Continuing my examination of “quality cyclical”, it is interesting to consider last Wednesday’s first quarter 2022 update from the mid-cap white-collar recruiter, PageGroup (LSE:PAGE).  

A 43% increase in gross profit – or net fee income, the key performance benchmark for an agency business – is impressive given the macroeconomic and geopolitical uncertainty, and also continued Covid restrictions in certain markets.  

All PageGroup’s territories are performing well – the laggard so to speak being China, up 23% relative to the fastest 79% growth in India followed by the US, up 60%. 

Moreover, a record £100 million gross profit was achieved in March, and operating profit for 2022 as a whole was guided slightly ahead of consensus for £202 million. 

Round up the recent City consensus guidance for £148 million net profit to £150 million, and earnings per share (EPS) of near 47p implies a forward price/earnings (PE) just under 10x – with the stock currently at 460p. 

Notionally, if 41.7p a share, combined ordinary and special dividends in respect of 2021are sustained, the yield is over 9%.    

Pricing of PageGroup shares therefore says investors are wary of forecasts, recent payouts and confident outlook statements; that an almighty shock lies ahead as stagflation realities bite, leading possibly to global recession. PageGroup is a true international business deriving just 15% of gross profit from the UK. 

It is a stark test-case as to stock market efficiency: either investor pessimism or managerial optimism is going to be proven wrong here. 

For what market adages are worth: beware “fools’ gold” of cyclical stocks that look cheap ahead of a recession; conversely, “the market has predicted nine of the last five recessions”! 

Operational gearing relative to shifts in the wider economy, is key  

Last July, I compared PageGroup with small-cap Robert Walters (LSE:RWA) when both recruiters traded on forward PE multiples over 20x. Both stocks had recovered to pre-pandemic levels and traded at the same 27% premium to end-February 2020 lows. I queried if this might be a warning sign about how “cyclical stocks on growth ratings” marked a signal to sell equities generally? 

Quite a large range of small-caps have declined since last September. 

While I have noticed PageGroup had sustained a PE as high as 20x in past years, I suggested risk-conscious investors might prefer to lock in some gains due to the range of possible scenarios. Broadly: “hold” both recruiters but refine your action according to your outlook and risk tolerance. 

Now, as eight months ago, I suspect operationally geared companies – i.e. where revenue changes are magnified at the profit level – are in a dilemma as inflation tests double digits.  

Allowing a recession may be the only way the authorities can hope to temper inflation.  Central banks cannot raise interest rates over 2% - which is piffling compared with 10% to 20% used to tackle inflation 30 to 40 years ago – without causing a debt bust. 

Robert Walters is characteristically guarded on prospects 

Both stocks continued rising for the rest of 2021: PageGroup from 585p in July to 670p in November, and Walters from 755p over 860p in early 2022.  

But they started falling well before Russia’s invasion of Ukraine took prices down to 432p and 542p respectively. This shows how cyclical stocks can shift in unison on wider expectations irrespective of company releases: these falls were 36% and 37%. 

Like I have discussed regarding furniture retailers ScS Group and DFS Furniture, company analysis has limits when cyclicals face a potential economic turning point. 

Walters has recovered to 675p, although 700p was achieved at end-March before the first-quarter 2022 update on 7 April cited a 30% advance in gross profit.  

The eponymous CEO was characteristically cautious about revenue visibility, offering no insights beyond “current trading in line with expectations” - although staff numbers have risen 9% this year to take advantage of demand. A “hold” stance broadly applies to the stock you will need to be flexible with.  

Taking a cautious view, it is possible to regard circa £150 million net profit for PageGroup this year as “peak earnings” relative to the trend since 2015 (see table).  So much depends on what happens next in the big picture. 

PageGroup - financial summary
Year end 31 Dec

  2015 2016 2017 2018 2019 2020 2021
Turnover (£ million) 1,065 1,196 1,372 1,550 1,654 1,305 1,644
Operating margin (%) 8.5 8.4 8.6 9.2 8.9 1.3 10.3
Net profit (£m) 66.2 72.1 83.1 104 103 -5.7 118
Reported earnings/share (p) 21.1 23.1 26.4 32.4 32.2 -1.8 37.0
Normalised earnings/share (p) 21.3 23.1 26.4 32.4 32.2 -1.7 37.0
Return on capital (%) 39.5 39.3 40.8 42.1 33.5 4.3 34.8
Operating cash flow/share (p) 26.3 28.4 27.4 28.3 48.9 42.9 45.4
Capex/share (p) 4.8 8.1 6.7 8.0 8.2 7.1 8.6
Free cash flow/share (p) 21.5 20.3 20.8 20.3 40.7 35.8 36.8
Ordinary dividend per share (p) 11.5 12.0 12.5 13.1 13.7 0.0 15.0
Special dividend per share (p) 16.0 6.4 12.7 12.7 12.7 0.0 26.7
Covered by earnings (x) 0.8 1.3 1.0 1.3 1.2 0.0 0.9
Cash (£m) 95.0 92.8 95.6 97.7 97.8 166 154
Net assets per share (p) 68.0 75.6 82.6 97.0 98.7 96.1 103

Source: historic company REFS and company accounts.

Is stock pricing fair in respect of risk and yield? 

Walters’ conservatism applies also to dividends relative to PageGroup’s distributive zeal. At 675p, Walters offers a 3% yield based on consensus for the payout to rise to over 20p a share – covered around 2.7x by expected earnings. 

The tables show how Walters’ cautious payouts enabled it to payout 4.5p a share in respect of 2019 (as Covid thwarted a final dividend in March 2020) which recovered to 15.5p in 2020; whereas PageGroup cut dividends entirely in respect of 2020.   

Robert Walters - financial summary
Year-end 31 Dec

  2015 2016 2017 2018 2019 2020 2021
Turnover (£ million) 813 999 1,166 1,233 1,216 938 971
Operating margin (%) 2.8 2.6 3.6 4.0 4.2 1.6 5.6
Operating profit (£m) 23.1 26.2 41.9 49.7 51.2 14.8 54.1
Net profit (£m) 15.3 19.9 29.3 35.6 34.0 5.7 33.5
Reported earnings/share (p) 18.7 25.4 38.9 45.8 44.9 7.5 43.7
Normalised earnings/share (p) 19.3 26.0 39.5 46.2 45.0 8.9 43.0
Return on capital (%) 24.7 25.2 33.9 32.2 23.3 6.8 23.7
Operating cashflow/share (p) 19.3 37.6 42.4 80.8 92.3 131 43.9
Capex/share (p) 7.3 6.4 9.3 8.1 12.6 13.1 17.2
Free cashflow/share (p) 12.0 31.2 33.1 72.7 79.7 118 26.7
Dividend per share (p) 7.1 8.5 12.0 14.7 4.5 15.5 20.4
Covered by earnings (x) 2.6 3.0 3.2 3.1 10.0 0.5 2.1
Cash (£m) 43.4 62.6 61.9 79.9 112 156 142
Net assets per share (p) 119 133 162 202 211 222 228

Source: historic company REFS and company accounts.

PageGroup then resumed its bold approach – returning £100 million, according to the cash flow statement – by way of interim and special dividends last October. This was aided by cash swelling as trading proved more buoyant than feared. Despite the payout representing 84% of annual net profit, end-2021 cash eased only 7% to £154 million. 

A final dividend of 10.3p to be paid in mid-May will take the total payout up to 41.7p.  

PageGroup is canny to pay ordinary and special dividends, prioritising shareholders with returns yet reminding them of a variable element.  

Yet the way the special dividend more than doubled to 26.7p in respect of 2021 was effectively a “balancing up” after 2020 caution proved overdone. 

The 2021 cash flow statement shows £149 million net cash generated from operations after-tax, versus investment absorbing just £25 million. When the going is fair to good, PageGroup is a cash machine. 

Say the special element reverts to 12.7p with slight growth in the ordinary to 16p, then a 28.7p total represents a 6.2% yield at a 460p share. That compares with just over 3% expected for Walters at 678p. 

Even if PageGroup slashes its special dividend in the face of a downturn, a 16p ordinary (although consensus is for over 20p) would cost nearly £53 million, the balance sheet easily underwrites.  

The prospective yield would then be 3.5%, still ahead of Walters. 

I was therefore a bit surprised to see Walters' stock rise yesterday versus PageGroup’s fall; but it underlines liquid cyclicals being sold off.  

PageGroup proclaims: “a resilient highly diversified business model, with focus on high-potential disciplines such as technology, healthcare and life sciences – delivering robust results during the pandemic and in the recovery.” 

Large and high-potential geographic markets saw a 60% collective rise in net fee income last year, to represent 38% of the group. 

Like Walters, PageGroup has continued itself to hire, with around 700 staff added last year after 400 in 2020 – taking the fee-earner headcount up 1% on end-2019. 

A sceptic would say, these are fine financial PR words and recruiters will need to swiftly reverse expansion once a downturn bites. 

Put PageGroup on a prospective buy list 

That both stocks are quite impossible to rate amid such uncertainty helps explain weakness, as buyers sit on their hands. If equities continue to fall in response to economic fears, cyclicals are liable to bear the brunt. 

Yet carnage means a buying opportunity and, while right now could be premature, bear in mind PageGroup’s global operations, cash generative model and priority for shareholder returns. Buy.    

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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