Stockwatch: Still time to recruit value here

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Is it too late to back recruitment stocks? This has been a worry after the economic cycle extended longer than usual, boost by central banks. It helps explain rising recruiter shares, although AIM-listed Empresaria (EMR) has also announced strong interim results.

From a recent 85p to 90p range, the EU referendum triggered a drop to 75p, but the stock has clawed itself back, and more, to 103p, remaining modestly rated on earnings. The forward price/earnings (PE) multiple reduces to single figures versus earnings per share (EPS) percentage growth in the high teens to low twenties, hence an attractive PE-to-growth (PEG) ratio of 0.6 to 0.4, where sub-1.0 spells value.

This being a classic growth stock measure, it could get compromised by a surprise downturn. Furthermore, the dividend yield is barely over 1.0%, so an adverse change to the earnings scenario is going to affect sentiment. But, in terms of its overall risk/reward profile, Empresaria already discounts plenty of risk, while good news promptly tweaks upside.

Who is the fairest of them all?

There's some rationale for this after Empresaria's lacklustre performance in 2011, when the adoption of new collective bargaining agreements in Germany was blamed for a 32% fall in pre-tax profit; although some dissatisfaction with the chief executive was implied, given there was a new boss appointed in January 2012.

Modestly-rated Empresaria has made very good progress in a five-year chart contextCompany REFS cites an annual average historic PE rising steadily from 4.7 times in 2012 to 9.1 times this year, which compares with 16.5 times for Robert Walters (RWA) in the FTSE SmallCap index and 18.5 for PageGroup (PAGE) in the Mid 250. Walters even averaged 30 times and higher over 2013 to 2015, since when its stock has de-rated by a third, with PageGroup trading similarly.

They show a risk of highly-rated cyclical stocks, i.e. don't push your luck if they achieve a growth rating. By contrast, the modestly-rated Empresaria has made very good overall progress in a five-year chart context, up from about 20p despite consolidating this year since an end-2015 high of 106p.

Diversity and sterling hedge

The chief executive lauds the benefits of diversity by geography and sector - if oriented towards professional and specialist jobs - which has delivered 12 consecutive quarters of balanced growth.

Translating overseas earnings into strong sterling meant a headwind last year, but now results are split into relatively lower "constant currency" figures versus those enjoying a boost from sterling weakness.

Thus, net fee income (gross profit, which tends to be the key performance measure of agency businesses) rose 9% at constant currency or 13% overall to £27.2 million, on revenue up 11% at constant currency or 15% to overall £106.1 million.

The German market is said to remain positive and it's important it doesTemporary and contract revenue is driving this, while permanent jobs are nearly flat, suggesting recruiters need to be adept in short-term employment while client firms are cautious at making commitments and are keeping costs down.

Growth has also all been overseas. With the UK representing 34% of net fee income, its first-half figures were flat as hiring slowed ahead of the EU referendum. Another 30% is continental European-derived, with Germany and Austria representing 94% and helping net fee income there up 15% at constant currency.

The German market is said to remain positive and it's important it does; otherwise, there is a relatively small Finnish healthcare business in a positive trend due to cost reductions in a weak market.

Then there is Asia Pacific, with 29% of net fee income, up 2% in constant currency, with Japan, India and China doing well but Indonesia and Thailand down; also the Middle East (included) was hit by the oil price fall, impacting a purely permanent market, but which should remain profitable and where infrastructure jobs demand is expected to increase. Lastly, the Americas represent 7% of net fee income, covering pharmaceuticals in the US and start-ups in Mexico and Chile.

If the firm's outlook statement is right, it's only a matter of time before there's a better ratingAltogether it's quite a lot and offering mixed performance,  albeit no trouble to set the group back. The chief risk remains a slowdown in Germany, though this is mitigated by Empresaria's bias to temporary employment.

In July the group acquired 82.6% of Rishworth Aviation for £7.5 million, a New Zealand-based recruiter providing pilots and aviation personnel globally. It's contract-oriented, with pilots typically on three-five years and achieved an equivalent £1.9 million operating profit on £73 million revenue in its year to end-March 2016. The hope is a strong growth profile continuing, especially in Asia and Africa.

Empresaria's outlook statement is bullish: "We see strong growth opportunities across the group and we remain confident in our ability to deliver increasing profits."

If so then it's still appropriate to buy in and only a matter of time before there's a better rating, the same way Page and Walters had to drop. Eventually the market weighs value.

Low balance sheet risk

If Empresaria was debt-heavy following acquisitions, that would part-justify its low rating. Long-term bank loans are up from £3.8 million to £13.2 million, June-to-June, while short-term debt is steady at £12.4 million, but cash is also up from £6.3 million to £15.4 million and the finance cost on this £10.2 million net debt clipped only 9% of operating profit.

Capital growth likely remains the priority: further acquisitions and limiting debt increasesWhile Rishworth has been bought with new five-year debt, management says the company holds £7.0 million equivalent cash so there will only be a small increase in net debt. Admittedly, the balance sheet is goodwill-heavy - 71% of net assets - but such is an acquisitive "people business".

I drew attention a year ago at just over 80p with the forward PE then about nine reducing to eight times, relative to over 20 times for Page/Walters. Empresaria's rating is actually lower now, according to forecasts produced on 21 July by Arden Partners, the company's broker.

Possibly a reason for this is the dividend having earnings cover over 10 times, i.e. if the board is genuinely confident then why not return more to shareholders? Capital growth likely remains the priority i.e. further acquisitions and limiting any increase in debt.

The stock only needs to achieve earnings of 12p on 11 times, to show 30% upside.

For more information see the website.

Empresaria - financial summary Consensus estimates
year ended 31 Dec 2011 2012 2013 2014 2015 2016 2017
Turnover (£ million) 209 194 194 188 187    
IFRS3 pre-tax profit (£m) 1.9 3.6 4.9 5.9 7.1    
Normalised pre-tax profit (£m) 4.1 4.3 5.2 6.0 7.3 9.1 11.0
Operating margin (%) 2.0 2.5 2.9 3.4 4.1    
IFRS3 earnings/share (p) 0.6 3.0 5.2 7.5 9.3    
Normalised earnings/share (p) 5.5 4.6 5.9 7.7 9.7 11.3 13.6
Earnings per share growth (%) -14.9 -17.4 28.4 31.5 25.9 15.9 20.6
Price/earnings multiple (x)         10.6 9.1 7.6
Price/earnings-to-growth (x)         0.4 0.6 0.4
Cash flow/share (p) 2.9 6.3 12.3 11.9 11.6    
Capex/share (p) 1.6 1.1 1.8 2.2 1.9    
Dividends per share (p) 0.4 0.4 0.4 0.4 0.7 1.1 1.3
Yield (%)         0.7 1.1 1.2
Covered by earnings (x) 12.5 10.5 13.5 18.0 15.3 10.2 10.9
Net tangible assets per share (p) -7.2 -13.5 -9.9 -4.7 -3.5    
Source: Company REFS

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.