Stock to Watch: Hays

How soon should you buy into shares that are capitulating on the economic fears?

The extent of fears could be misplaced and some situations now offer an attractive yield; also their reported results may look strong, but of course they represent the recent past while the future is what counts.

History tends to show, low price-earnings multiples at the early stages of a recession can prove fool's gold, only to go lower. See how analysts have already been caught out projecting ample profits for the likes of Flybe Group and Mothercare, now being slashed.

But unless you study what evolves and consider tip-toeing on the equities wreckage, you are watching your cash erode from inflation. And at some point you will miss the upturn, be that in individual shares oversold or a wider market recovery. So eyes down!

Hays is a good example of these dilemmas. The FTSE 250 shares in this specialist recruitment group have more than halved this year to 66p by early October, almost revisiting the 55p low at end-2008.

Reports on the UK jobs market cite a contraction; yet Hays' latest interim management statement for the quarter to end-September shows the group is managing to buck modest weakness in the UK with strong growth elsewhere. In the June to September quarter 68% of net fee income was generated internationally.

While like-for-like net fee income fell 4% in the UK and Ireland, it jumped by 21% in Asia Pacific, even 34% in continental Europe (principally Germany) and rest of world.

Overall the group achieved 15% growth, boosted by 27% internationally; 19 countries across the group achieved growth of 20% or more, within which 10 countries grew by over 40% including Brazil and China. Questions exist generally, whether China may see a hard landing, but momentum abroad looks healthy overall.

Get more on the economies in Brazil and China inthe Interactive Investor Guide to BRIC.

Crucially on the outlook, management says that trading remains "robust" in the vast majority of international markets, albeit in the UK the private sector has slowed. UK public-sector markets are said to be broadly stable although the stockmarket probably suspects that government spending cuts will have some effect. Mind that visibility may only be a few months in recruitment, before signs of change.

Company REFS shows a flurry of broker 'buy' recommendations in September, although the shares have fallen further in response to economic fears. Forecasts range considerably, from pre-tax profit of £110 million to £150 million for the current year to end-June 2012 - relative to £107 million this last year - then another big jump near a consensus £160 million for 2012-13.

Yet analysts range even more widely, from a fall in pre-tax profit to £103 million, to a massive £194 million. While it is good to see them projecting independently of management guidance, it shows how varied the scenarios can be - according to how the global economy trends.

Indeed, a current fear of mine is many company forecasts being at risk of economic change: witness the savage downgrades for Flybe and Mothercare this last week, in response to updates.

Yet Hays is a relatively more stable business. It is not operating on a 2% margin like an airline, or mainly exposed to UK consumers under pressure. Mind that it was still hit hard after the 2008 financial crisis: normalised pre-tax profit slumped from £249 million to £71 million by 2009/10. At least recent analysts' projections are well within what Hays showed it could deliver for a number of years before the crises.

Its shares do not merit a low multiple of earnings per share, at least for long.

While the price-earnings multiple slumped from the mid-teens, just below 10 times in 2008-09, it soared to an average 20 times during 2010-11 as the market anticipated sustainable recovery. It has recently plunged to the low teens according to your view on forecasts.

The dividend initially looks supportive at the current share price level around 70p - implying a yield of about 8%. Despite the 2008/09 crisis it rose from 5.25p to 5.8p a share and been sustained at this level, albeit uncovered by earnings per share.

The 2010/11 cash flow statement shows nearly £80 million paid as dividends, compared with £82 million cash generated from operations and balance sheet cash down from £75 million to £55 million. So the dividend is looking pressured and depending on management's investment plans it may need to be cut - even though most brokers' analysts expect 5.8p a share for the next two years.

The economic trend will be the deciding factor, but in de-rating the shares to about 70p the stockmarket sees more risks for the dividend than do brokers.

The balance sheet is also a classic "people business" with £183.5 million goodwill and £62.9 million other intangibles, in context of £196.4 million net assets. Net debt increased from about £135 million to £175 million, June 2010-11, explained due to the timing and phasing of cash flows.

So neither the dividend nor balance sheet can be said to provide firm support; Hays' valuation emphasis is earning power which could swing with the economic trend. Yet this remains one of the better quality cyclicals to follow after it falls, as it will recover in time.

The next comment on trading should be at the 9 November AGM, and again in the New Year for Hays' first half to end-December. If you are bearish on the global economy then hold off, but if current fears are excessive and the European debt crisis is contained, then the shares ought to be around a low point now - even if the dividend is trimmed. So at about 70p, Hays has become a priority to consider accumulating.

For more information see hays.com.

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