Stockwatch: Stars align for this share

Does a prospective yield over 5% and stock rising from a chart support point imply upside? At about 78p, shares in professionals' recruitment and outsourcing group Harvey Nash have a low-growth earnings profile, offset by the total dividend expected to rise to 4.0p as earnings cover reduces from about 3.0 to 2.3 times.

We've just seen AIM-listed Penna Consulting Group, a similar operation, get snapped up by Adecco on an exit price/earnings (PE) multiple in the high teens, compared with just over 8 times presently for Harvey Nash, with Penna boasting a stronger, if volatile, growth profile.

My point is not to ignore smaller companies that are potentially useful bolt-ons for larger groups currently challenged to achieve organic growth - also because, on fundamentals alone, the small-caps may yet trend higher.

Chart 'bowls' help fulfil hopes

They initially appeared with mining stocks around February, when panic selling eased and speculative buying commenced, creating bowl-like patterns which chartists typically see as bullish. Though it's unclear to what extent it was causal or coincidental, mining stocks then soared as the market regained risk appetite, with a near-50% jump in oil prices.

The 2016 market context has, therefore, seen New Year panic selling decelerate, modest buying take over, then individual stocks spike where company results meet expectations. So, there are quite a few such "bowls" - like Harvey Nash's chart over February to end-March, which is interesting ahead of prelims on 28 April.

Mind how it's tempting to read such concepts into chart patterns, although behaviour can and does recur. The legendary Jesse Livermore was blunt about this: "Nothing new ever occurs in the business of speculating or investing..."

Admin costs check profits growth

The table shows strong revenue growth of 66% over five years, which would conventionally define a growth company. On this timescale earnings per share (EPS) have also advanced, then consolidated since 2012.

From the interims to end-July 2015, gross profit rose an impressive 9.4% at constant currency despite near-static revenue, with adjusted pre-tax profit up 7.3% or 12.6% at constant currency.

The "adjusted" aspect of non-recurring costs was cited as £0.4 million relating to a review of a German outsourcing business, although the income statement showed total administrative expenses up from £39.0 million to £41.4 million, like-for-like.

The long-term trend shows the operating margin fairly constant, if declining slightly to about 1.4% by 2014/15; however, admin costs appear a nuisance currently: e.g. a 26 February pre-close update cited full-year profits in line with market forecasts, with all areas of the group showing gross profit progress (in constant currencies) - ranging from the UK/Ireland up 4% to Asia Pacific up 38%. By activity, gross profit for the latest year has risen 10% in permanent recruitment and offshore services, and 8% in contract recruitment.

Yet the consensus expects only 2.2% normalised profit growth and 1.1% for EPS, i.e. admin costs are clipping growth. The interims also show taxation rising from 28.1% to 31.1%, a modest check also.

While gross profit tends to be promoted as the key performance measure of any agency-type business, investors are naturally perturbed when bottom-line EPS differs from the "strong trading/growth" management proclaims. So the 2015/16 results need to better clarify rising admin costs, as it's easy to suspect higher management pay.

Are jobs growing faster than the real economy?

The pre-close update cited Harvey Nash enjoying a 25% increase in US actual gross profit, helped by dollar strength, with a 16% rise at constant currency.

This quite defies scepticism that US jobs' gains are focused on low-wage industries: the interims cited strong demand for technology professionals in the US, although the fastest-growing region was Asia-Pacific at around 40% as Hong Kong, Japan and Vietnam easily offset a (part currency-related) fall in Australia.

It's interesting to consider to what extent this reflects tightening of labour markets, i.e. firms hiring because productivity has peaked and they cannot get more out of existing workers. This is relevant to US financial markets, where the Federal Reserve is cautious to raise interest rates despite stronger jobs.

It could reflect what investors fear most: that central bank measures have become ineffective as to the underlying economy, while a tight jobs market is medium-term inflationary. So the US could be approaching "stagflation" as the Fed dithers to normalise interest rates - a scenario that could mean rates going materially higher if inflation jumps.

The geographic performance of a small-cap UK-listed recruiter, therefore, points to a risk for global equities, now PEs are the mid-to-high teens - i.e. higher than 2008 - after years of monetary stimulus.

How buyers should profit

In a wary context the market pricing a recruiter like this - to exact a 5% yield - becomes rational, also because visibility in recruitment can be limited. Yet cautious sentiment can get overdone, and be just what acquirers hope for.

Shareholders might be content to accept a 35% premium, say around 105p a share, with an exit PE multiple around 11 times also useful for an acquirer. Added to a capitalisation of £57 million with the stock at 78p, at end-July there was £15.7 million net debt (up from £4.3 million year-on-year).

Bid speculation is not to be relied on, yet those chunky buys recently going through the market - asserting the next side of the "bowl" - should be in profit if management affirms a confident outlook at prelims.

For more information see their website.

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.