Stockwatch: A sector full of classic momentum plays

Does strong international progress at recruitment agencies - Robert Walters being the latest - make nonsense of deflationary fears? Can they be viewed as a sign of corporate confidence continuing to build, i.e. a positive for equities?

On 8 April a bullish update from the FTSE SmallCap-listed Robert Walters provided a stark contrast to gloom expressed the day before by the International Monetary Fund. Its latest report warns the global economy is caught in a low-growth trap as populations age and innovation wanes, as it continues to reduce its growth rate since the 2008 financial crisis and shows no sign of returning to normal. Walters and other recruiters imply the IMF is excessively gloomy like some economists were in the late 1930s towards the end of The Great Depression - when the term "secular stagnation" was coined, being repeated nowadays.

In the first quarter of 2015, Walters' like-for-like net fee income contribution advanced by 15% at constant currencies or 12% on a statutory basis, to £53.9 million. This gross profit measure is often a benchmark for agency business' performance, benefiting from the UK being Walters' second-largest earner at 34.5% of the total, and where net fee income is up 22% amid "a broad-based upturn in permanent recruitment activity across both London and the regions." Such evidence defies criticism the UK recovery is imbalanced with London pre-dominant, additional to being debt-based and consumer-driven. George Osborne can take heart.

Professionals' recruitment is on a roll

And despite fears the eurozone structure has mired the Continent in recession, Walters' European net fee income has risen 12% in constant currency with contract business in France and Benelux continuing to perform well, also permanent recruitment activity remaining strong in Spain and Ireland.

Altogether, Europe represented 20.6% of group total and it’s hard to regard a double-digit rise as divorced from business confidence. Positive trends prevail also in Walters' smaller operations - he US, Middle East, South Africa and Brazil - which account for 5.8% of the total, with net fee income up 44% in constant currency. The Middle East rather skewed the outcome by more than doubling net fee income, and of course the US economy has performed well.

It reinforces a message from the 2014 prelims six weeks ago, how professionals' recruitment is enjoying widespread progress. UK net fee income growth was cited at 24% for the year, Asia Pacific up 8% at constant currency, similarly Europe up 10% and other international up 35%. With balance sheet cash nearly doubled to £13.1 million, it amply justifies a 13% rise in the final dividend to 4.35p, covered 3.5 times by earnings per share up 82% to 15.3p. Walters' staff numbers have grown both in emerging markets and mature economies, another sign of broad-based progress.

Has QE benefited financial and legal jobs, unduly?

To be picky, loose monetary policies - especially quantitative easing - have boosted asset prices thereby transactions, helping to explain current prosperity in these service sectors and a knock-on effect for areas like human resources and IT. Walters doesn't provide a breakdown of recruitment specifics, however the introduction page on its website cites: "accountancy and finance, banking and financial services, legal, human resources, information technology, marketing, sales, secretarial and business support, and tax and treasury."

Finding non-QE influenced reference points in the sector is tricky because mid-cap rival Michael Page has a similar profile; likewise Hays in the FTSE 100 index. Hays is also exposed to construction and property, arguably another beneficiary of asset inflation. Not surprisingly the listed recruiters focus on relatively more prosperous sectors, although they remain cyclical and a downturn is inevitable at some point. But it's hard to dismiss the currently strong results as fleeting; their momentum appears intact.

Hays' interims for the six months to end-December 2014 cited 30% like-for-like operating profit growth at constant currency and "an acceleration in the permanent recruitment market, as candidate confidence continues to improve in many countries." Michael Page enthused similarly when reporting 2014 prelims on 11 March, with operating profit up 23.8% and earnings per share measures advancing about 22%. "The underlying business environment is more positive in some of our key markets, with improving momentum in the second half."

Operational gearing as a double-edged sword

These businesses benefit also from increases in net fee income dropping through easily to the bottom line; quite why Hays trades on a 12-month forward earnings multiple of about 18 times, Page about 25 times and Walters about 20 times as upgrades start to appear (not yet reflected in the table). These stocks are now classic momentum plays - fully-priced with regard to longer-term risks in the business cycle, but where news looks likely to remain positive. They are therefore interesting on a trading view as buyers respond to chart highs, with the likely effect of becoming short-selling candidates when macro data or trading updates deteriorate.

Fundamentals and sentiment get inter-twined partly because operational gearing - especially for a relatively smaller firm like Walters - boosts results hence expectations; then if the music appears to stop the reaction can be severe. So long/short traders will find plenty of interest. Conservative investors can also take heart, in a week when Julian Robertson - a grand-daddy of the hedge fund industry - joined the doomsters, warning the financial asset bubble will burst.

The concluding, key point is recruiters' bullish progress reflecting corporate confidence to invest. This is a vital fundamental just when US equities are likely to be tested as first-quarter reports reveal some harm to earnings from US dollar strength.

For more information see: robertwalters.co.uk.