Stockwatch: Two quality cyclical shares

by Edmond Jackson from interactive investor |

After missing out on the early 2019 stock-rally, now could be the time for this pair to counter institutional selling, believes companies analyst Edmond Jackson.

Does wariness of even the most successful international recruitment stocks, imply the undertone to the equities rally in 2019 could easily waver?

A genuine China/US trade accord is yet to be proven, meanwhile Chinese mobile giant Huawei has turned its guns to sue the US government, and Brexit looks irresolvable. Risk factors remain very real.

While some stocks hit hard in the second half of 2018 have recovered some poise, others remain very much out of favour, including recruitment companies, which are seen as cyclical.

Two of these companies that I follow have just declared excellent progress. Last January, I drew attention to circa £430 million Robert Walters (LSE:RWA) at 555p, given its Asia Pacific side was doing very well, despite its market price slumping from around 800p mid last year.

Annual results for 2018 show pre-tax profit up 21% to £49.1 million on revenue up 6% to £1.23 billion, and its stock has advanced to 600p which represents 11 times projected 2019 earnings, yielding a modest 2.7%.

That Walters' board tends to be cautious about earnings visibility is shown by cover for its dividend payout being well over three times. Also, cautious investors may wonder if the cyclically adjusted price/earnings (PE) ratio could be in the teens if we are looking at a global slowdown say in 2020.

PageGroup certainly appears confident by way of payouts

Now PageGroup (LSE:PAGE), a £1.5 billion business, has declared 2018 pre-tax profit up 20.4% to £142 million on revenue up 13% to £1.55 billion – they're quite similar metrics to Walters and helped by a strategic transformation programme. Both these companies are growing very well organically, unlike others who are boosted by acquisitions and where you have to decipher true earning power through a haze of exceptional costs.

Page is 17% ahead of consensus on profit, though earnings per share (EPS) of 32.4p was only 2% ahead, meanwhile a total dividend of 25.8p was close to consensus of 26p. See from the table how I’ve expanded to break down the ordinary/special elements of Page's dividend. These special payments began in 2015 as the benefits of cyclical upturn and central banks' stimulus programmes were maturing.

Presently, the expectation is for Page to continue to grow its total dividend, implying a 6% yield at the current share price of 442p (down from 620p mid-2018 and up only modestly from a 432p low this year). This ought now to constitute a support level, though be aware how (from the table also) Page's cover has narrowed to 0.8 to 1.3 times including special dividends in the last four years.  

Source: TradingView (*) Past performance is not a guide to future performance

The cash flow statement shows 2018 payouts costing £81.3 million in context of £90.7 million cash generated from operations and a net £23.8 million applied for investment; and the balance sheet cites £97.7 million cash at the year-end. So, this is a higher-risk payout policy than Walters', and I would expect the special element to be cut if recruitment markets fall.

Baffled by the global economy, investors trim cyclicals

The announcements of major shareholdings for Page are fairly typical of the circumstances and explain why its price/earnings (PE) multiple has fallen from the high teens (annual average historic multiples) to about 13 on a forward basis, versus 11 for Walters.

Last February, The Capital Group Inc, of Los Angeles, reduced its stake in Page from 6.8% to just below 5%, and Merian Global Investors (UK) trimmed theirs to below 5% (level unquantified). This has happened despite both recruiters’ outlooks being about as positive as it’s reasonable to be currently.

Page derives 17% of its gross profit (the performance benchmark for agency firms) from the UK versus 27% for Walters.  Some 53% of Walters' gross profit derives from "the UK and Europe" whereas Page merges Continental European income with Africa and the Middle East – "EMEA" – as 48% of gross profit. 

As things stand, No-Deal Brexit remains a possibility after a short extension to Article 50, or gets kicked into the long grass with a second referendum. Uncertainty would therefore persist for the UK and Europe at a time when Germany already teeters on recession after a drop in Chinese exports. Hardly surprising, therefore, that institutions are edgy about stocks perceived as cyclical.

Walters is more attuned to Asia Pacific which represents 39% of gross profit versus 20% for Page, which also derives 15% of its total from the Americas – unlike Walters, with no such exposure. So, you take your view about whether Asia Pacific is more likely stronger than the US for the medium term.

PageGroup - financial summary             Estimates
year ended 31 Dec 2013 2014 2015 2016 2017 2018 2019
Turnover (£ million) 1,006 1,047 1,065 1,196 1,372 1,550  
IFRS3 pre-tax profit (£m) 64.1 80.4 90.7 100 118 142  
Normalised pre-tax profit (£m) 66.5 80.7 91.4 100 118 142 135
Operating margin (%) 6.8 7.7 8.5 8.5 8.6 9.2  
Return on capital employed (%) 40.7 45.0 49.2 48.4 50.5    
IFRS3 earnings/share (p) 13.7 19.1 21.1 23.1 23.1 32.4  
Normalised earnings/share (p) 14.5 19.2 21.3 23.2 26.4 32.4 35.0
Earnings per share growth (%) 2 32.4 11.1 8.6 13.8 22.7 8.0
Price/earnings multiple (x)           13.6 12.6
Historic annual average P/E (x)     26.2 18.1 19.8 20.1 14.4
Cash flow/share (p) 17.3 23.4 26.8 28.4 27.4    
Capex/share (p) 4.1 3.9 4.8 7.5 6.1    
Ordinary dividend per share (p) 10.5 11.0 11.5 12.0 12.5 13.1 13.8
Special dividend per share (p)     16.0 6.4 12.7 12.7 12.7
Dividend yield (%)           5.8 6.0
Covered by earnings (x) 1.4 1.7 0.8 1.3 1.0 1.3  
Net tangible assets per share (p) 51.9 55.2 56.9 64.0 72.2 87.2  

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

No latest guidance from insiders' trading

As yet there hasn't been any post-results activity, save for Walters' executive directors deferring their annual bonuses into ordinary shares, as part of remuneration policy conditions anyway. Chief executive Robert Walters did however buy 29,000 shares at 514p last December to own nearly three million before a closed period on dealings. 

It would appear the Page directors have been using their option scheme to add to holdings, where last December there was some selling to cover the cost of exercising options, and taxes arising.

2009 downturn shows the risk to recruiters

Page's chief declares: "Our flexible and diversified business model ensures that we are able to respond quickly to changes in market conditions" - but this is quite a sop because the costs of maintaining global reach mean profits will fall more sharply than revenues.

Referencing annual reports for when Page was called Michael Page International, 2009 saw revenue down 26% to £717 million, but pre-tax profit plunged 85% to £21.1 million. The group did then recover in 2010 to £832 million revenue and £101 million of profit, but such a precedent is illustrative.

Cautious investors will be mindful about how analysts make mistakes of extrapolating revenue/profit around cyclical peaks and troughs, hence the odd situation of selling strength like two of Page's owners have recently done to hedge risk.

Yet longer-term value should be affirmed

Page continues to evolve towards a strategic vision of £1 billion gross profit (versus £815 million in 2018) and £200-250 million operating profit (versus £142 million), with various operational improvements.

If its stock market value remains modest, or falls further, both Page and Walters become takeover targets, especially if sterling falls further amid Brexit uncertainties. Walters could appeal to a US group seeking to diversify, offering its eponymous founder/CEO a chance to retire in due course.  
Page is a quality operation able to re-rate another group's prospects. Or Page's strong cash generation, underlined by its bold payout policy, could attract an audacious private equity bid.

My conclusion is that both stocks representing a 'hold' for those owning already, but also meriting attention for fresh money according to how Brexit and the global economy evolve.

If No-Deal is thwarted and if the US is seen to cut a satisfactory trade deal with China, stocks sold off late last year would represent lower risk, and for those like Walters and Page which have stayed down this year.

In particular for Page, sentiment could twitch towards both dividends at least being maintained, attracting income/recovery buyers on the basis a 6% yield must reduce (i.e. stock to rise). Thus a ‘buy’ case currently, somewhat according to events.

If the global situation deteriorates, both should be kept in the frame especially if sterling drops. Speculative Buy.

*Horizontal lines on charts represent levels of previous technical support and resistance.

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

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