Stockwatch: A share thriving in market turmoil

How much further upside do recruiters have? It's a question I posed last June after drawing attention to strong underlying momentum at AIM-listed Penna Consulting. Prelims to end-March showed pre-tax profit up 70% on revenue up 22%, earnings per share (EPS) up 131% and the dividend doubled. Combining recruitment and talent assessment is quite a unique selling point and I concluded that if the UK economy and recruitment trend remain broadly intact, a 'buy' is implied.

Penna's shares have since risen 80% from 170p to 305p, capitalising the group at £80 million; even so the prospective yield is about 3%, possibly more, considering forecasts (see table) were made on 11 November by Panmure Gordon, the company's broker, after interim results.

Since then, the final quarter of 2015 (Penna's Q3) has shown stronger momentum with "a further substantial increase in the level of trading" according to the latest 7 January update.

Clients are increasing their spending and new clients are being won; also margins are higher, thus pre-tax profit for the 9 months to end-December has soared 51% to £4.92 million against £3.25 million, like-for-like.

The 11 November forecast projected a 30% increase in pre-tax profit for the year to end-March 2016, yet management says its expectations for the current year have been "materially increased" - i.e. Penna may at least hit the 2017 forecast of £6.5 million, and possibly about £7 million, this current year.

Cash flow boosts dividend

A modest 25.8 million share issue helps profit drop through to per share measures, hence I would target 2015/16 EPS of 20p to 23p i.e. a forward price/earnings (PE) multiple in the mid-teens. This may appear in a fair value range, for what is ultimately a cyclical stock, although momentum should continue a while yet and bullish stories are hard to find.

Company REFS shows Penna's annual average PE re-rating from 11.8 and 9.1 in 2012/13, to 22.2 in 2014 when the stock reached a 152p annual peak. The market's anticipation in rating Penna on an average 16.5 times historic earnings in 2015 is also proving correct (by way of the latest update).

Additionally, the company has a respectable cash flow profile and, despite an expected re-rating of the dividend from 3.5p to 8p and higher, this was projected to be covered more-than twice by earnings - maybe getting nearer three times now.

More a momentum trade than tuck-away

Admittedly the five-year chart looks demanding for a fresh entry; the rush of upgrades since June shows how earnings expectations can vary - and that they won't always be on the upside. Alongside earnings, 91% of net assets are comprised of goodwill/intangibles (see the weak trend in net tangible assets), i.e. it can't limit downside risk, should earnings falter.

While this stock has less appeal as a tuck-away, it could still be entering a purple patch that defies any early stages of the UK economy weakening, given employment tends to be a lagging indicator. Note how, in the 10 November interims the chairman said: "The UK recruitment market has continued to strengthen but has yet to regain the levels of activity seen before the recession."

Economic volatility could actually be a boon for traders, boosting this stock higher, but liable to reverse as external influences hit UK confidence. If a spread bet provider can facilitate down bets then you may potentially profit both ways in the short and long term.

Public sector weakens volatility

Penna's extent of exposure is quite tricky to judge, but despite a wider sense of government cuts it can mitigate cycles in private sector hiring. Penna's Recruitment Solutions side constituted 68.7% of first-half group revenue, albeit 46.8% of operating profit versus Career Services, and it enjoyed a 16% profit rise: there was "particular success winning and delivering a number of large scale long-term contracts providing increased visibility for our future revenue streams."A diverse range of clients are involved "with particular strength in policing and security services, local authority and retail."

While it may be difficult - indeed commercially compromising - to give much detail, this is relevant to how durable Penna's profitability can be, thereby the stock's rating.

Also significant in this regard was the 21 December launch of a new digital service by the group's Career Services side, aimed to "support public sector clients as they enter a period of unprecedented departmental restructuring", which looks like good anticipation.

George Osborne looking for excuses

Ironically Penna's latest good news came on the same day the chancellor warned of a "cocktail of new threats", although his lining up of risks may also relate to difficulties delivering on public debt management.

As I mentioned before, a current virtue is Penna's UK focus - where the recruitment upturn appears the most vigorous globally, and should lag any economic softening, at least in the short term.

For a seventh year running, Penna has appeared in The Sunday Times' list of 100 best UK companies to work for - i.e. a quality business in a buoyant sector. With firms generally challenged, any such stock doing well gains investor attention, especially by institutions seeking dividend growth, which Penna offers also.

The time to worry will be when profit warnings accelerate, prompting less hiring in due course. This would also hit sentiment towards recruitment stocks, although Penna has no debt - so is less financially exposed - unlike some industrial cyclicals.

Risk still on the upside

While recruitment can look deceptively attractive, late in the economic cycle as other firms start to hit trouble, Penna has strong momentum it looks premature to call against.

Possibly a chief market risk would be any institutional holders deciding to reduce exposure while demand exists, although the last such announcement in November showed Helium Special Situations Fund increasing through the 7% and 8% stake levels. Penna is a special situation indeed, thriving quite independently in the current market turmoil. Panmure Gordon has just increased its target from 310p to 340p.

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This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.