There are clearly some significant macroeconomic risks ahead, but this company is typically one of the earliest to benefit after a recession. Analyst Edmond Jackson explains why.
Last January, I cautioned how recruiters warning of tougher market conditions were an interesting straw in the wind: both small-cap Robert Walters (LSE:RWA) and mid-cap PageGroup (LSE:PAGE) had noted their markets had toughened in the fourth quarter of 2022.
Walters has a more specialist/professional client base than Page, which covers a pyramid of personnel from executive search down to clerical professional and generalist staffing. I therefore thought that £1.5 billion Page might be more sensitive to a downturn, despite its equity being better-rated than £375 million Walters. Yet part of that value-differential will relate to “small-cap cyclical versus larger-cap” where the smaller is judged riskier, partly because it is less liquid.
Page has yet to update on its second quarter, but Walters is already pertinent – the details of its second-quarter 2023 update coinciding with a UK macro-economic warning from JP Morgan (I discuss later).
Mid-June profit warning means near-term prospects are priced in
Walters' stock is currently firm around 420p after a 14% drop to near 400p. That was in response to a 14 June update citing net fee income down 10% in the first two months of the second quarter. A trend of lower candidate confidence and lengthening time to hire, was not showing signs of improvement.
I suspect profits guided “significantly lower than expectations” in June, related to a higher cost base after the group expanded headcount and infrastructure over the previous two years. It would have reflected a moderate boom in the wake of exceptional monetary stimulus during Covid. Recruiters must now grapple with the effects of higher interest rates on business confidence, hence demand for staff.
Assuming recent consensus for a 33% drop in earnings per share (EPS) this year below 36p, the forward price/earnings (PE) ratio is 11.7 times and its yield 5.3%, covered 1.6 times by earnings. The dividend can be considered relatively secure given £123 million cash at the end-2022 balance sheet, and a long-term record of strong free cash flow given few capital expenditure needs.
Robert Walters - financial summary
Year-end 31 Dec
|Turnover (£ million)||813||999||1,166||1,233||1,216||938||971||1,100|
|Operating margin (%)||2.8||2.6||3.6||4.0||4.2||1.6||5.6||5.3|
|Operating profit (£m)||23.1||26.2||41.9||49.7||51.2||14.8||54.1||58.2|
|Net profit (£m)||15.3||19.9||29.3||35.6||34.0||5.7||33.5||39.1|
|Reported earnings/share (p)||18.7||25.4||38.9||45.8||44.9||7.5||43.7||53.4|
|Normalised earnings/share (p)||19.3||26.0||39.5||46.2||45.0||8.9||43.0||53.8|
|Return on capital (%)||24.7||25.2||33.9||32.2||23.3||6.8||23.7||23.8|
|Operating cashflow/share (p)||19.3||37.6||42.4||80.8||92.3||131||43.9||52.0|
|Free cashflow/share (p)||12.0||31.2||33.1||72.7||79.7||118||26.7||30.3|
|Dividend per share (p)||7.1||8.5||12.0||14.7||4.5||15.5||20.4||23.5|
|Covered by earnings (x)||2.6||3.0||3.2||3.1||10.0||0.5||2.1||2.3|
|Net assets per share (p)||119||133||162||202||211||222||228||246|
Source: historic company REFS and company accounts
That tempts a sense of there being value here, but the 2024 outlook is key: can the world avoid recession, enabling Walters’ net profit to rebound from £19 million expected this year, over £32 million next? On such a basis, the PE would ease to 9.1 times and the yield edges up to 5.7%.
Despite uncertainties as to the effects of higher interest rates on staffing demand, their cost should not compromise Walters’ income statement. At end-2022, the group had £26 million near-term bank debt and £76 million lease liabilities, giving rise to a modest £3 million net interest charge covered 19 times by £58 million of operating profit.
UK downturn coincides with JP Morgan macro warning
Walters’ latest update re-affirms a 10% decline in net fee income (or gross profit, the benchmark for a recruiter) at constant currency to £100 million. Notably, the UK has suffered the worst geographic decline, down 21% to £16 million.
Walters says: “Recruitment confidence levels in the UK continued to be impacted by the knock-on, macro-economic effects of a high inflation and high interest rate environment...activity levels impacted by lay-offs across the technology sector and financial services volatility. Legal recruitment remained relatively robust.”
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This is interesting as a reminder of how technology proves cyclical, despite the assumption from years of ultra-low interest rates that “growth” ratings imply resilience.
Simultaneously, JP Morgan warns how stubborn UK inflation may lead to 7% interest rates after 5% was reached last month. Its central forecast is 5.75% by November, but rates could go higher “under some scenarios”. Risks are rising of a 2024 recession as surging borrowing costs hit business confidence and raise unemployment.
Economists, generally, say current strength in the UK jobs market is adding to inflationary pressures after annual growth in average pay rose to the highest level in two decades last April, amid near-record job vacancies.
Mixed performance from Asia-Pacific operations
Asia-Pacific has seen an 8% fall in net fee income to £44 million as mainland China plunged 37% - the anticipated rebound from Covid disruption earlier this year yet to materialise. Australia also fell by 17%, albeit Japan by only 1%, which are the region’s two largest businesses.
China and Australia have skewed performance in a region otherwise doing well: Indonesia up 20%, Malaysia up 11% and New Zealand up 8%.
Asia-Pacific has traditionally been Walters’ driver, given Australians comprised the group’s original team and its eponymous founder. This contributed to a sense it is strategically positioned in the world’s most dynamic area, although fates of the US - and more pertinently nowadays, Chinese economy - can mean volatility for what are largely exporting nations.
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Consensus among economists is for roughly 6% Chinese growth this year and next - possibly helped by its central bank easing monetary policy instead of a tightening trend in the West against inflation. Yet the property market – which contributes significantly to Chinese GDP – remains weak and exports seem likely to slow along with the global economy.
Walters therefore reminds us how the global context is difficult. We cannot assume China will substitute for much US slowdown as higher interest rates take effect.
Europe flat and US sharply down
It is perturbing how Walters cites US net fee income down a whopping 47% - albeit small in group context, being lumped with South Africa and the Middle East as “other international”, which was down 26% to a modest £8 million.
Interestingly, the US plunge relates similarly as the UK, to technology and financial services. It helps explain why financial equities are generally weak (in anticipation of lower profits) and took the brunt of Thursday’s market sell-off in response to strong US jobs data that reinforced fears of interest rates continuing higher.
Meanwhile, South Africa and Mexico are doing well – net fee income up 23% and 93% respectively – although a relatively small arithmetic base may help.
Structural fundamentals of recruitment remain strong
Walters contends that job vacancy levels, salary inflation and candidate shortages are holding up, hence “when market confidence recovers there will likely be an increase in demand...”
I disagree, because central banks need to break this aspect of wage rises otherwise inflation becomes embedded in mid-single-digits – at best – rather than 2% targets being restored. That is if we take the monetary authorities at their word. Recessions therefore become inevitable given interest rates are their only tool.
So, I would not assume recruiters have reached “buy” territory despite confident 2024 forecasts – which similarly expect PageGroup's EPS to rebound 20% after a 32% slide this year. Look out for its update shortly, if only for further macro insights.
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Quite like JP Morgan on the UK economy, one’s base-case expectation does not change but risks are rising of a worse-case scenario.
Shareholders can at least take heart that the dividend looks to be lending support, particularly around the 400p level. And looking back to 2010, net fee income rebounded 49% to £155 million. A calibre recruiter is one of the early companies to benefit after a recession, the market will respect this by pricing its equity higher – before evidence of recovery materialises.
A case therefore exists to hold this stock (if you already do) through the uncertainty, with a view to add if economies turn grizzly. Hold.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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