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Stockwatch: A low rating and 8% yield
Is this a canary in a coal mine that's going cheap? A slump in the AIM-listed, engineering and technology recruitment stock Gattaca (GATC), formerly known as Matchtech Group, begs questions over whether it portends a downturn after seven-and-a-half years of UK economic growth; albeit priced in already.

The chart has been on a rollercoaster from 220p in 2012 up to 635p in 2014p, then back down to about 300p currently. The latest rally was in anticipation of Gattaca's rising earnings, but - at least at the top - shows markets' tendency to react in the extremes.

The table below shows Gattaca's annual average historic price/earnings (PE) multiple for 2014 reaching 17.5 times - a highly cyclical stock on a growth rating. This has slumped to 10.5 for 2016 and, if forecasts are fair, represents a forward multiple of about 7.

Moreover, the stock now yields 8%, with forecast earnings cover of 1.7 times backed by a very strong record of cash flow versus capital expenditure (see table again). Barring financial collapse, the dividend yield ought to be secure.

Good value

Reading across to Robert Walters (RWA), the £250 million FTSE small-cap recruiter quite similarly de-rated from 475p in 2015 to 250p mid-year, before jumping to 330p currently.

The PE context has been higher, well over 30 times and presently in the mid-teens, Walters' yield support being an immaterial 2.7%. Mid-cap PageGroup (PAGE) is down from 560p, also having traded over 30 times earnings, and is now on a forward PE in the high teens, yielding 3.9%.

Net fee income rose 6% in engineering and 9% in telecoms, but was offset by a 6% fall in technologySo, recruitment stocks are behaving quite similarly, although an 8% yield on Gattaca implies mispricing if the payout is at all realistic.

Latest prelims to end-July show net fee income - the crux performance measure for a recruiter - up 33% on a statutory basis to £73 million, albeit flat in underlying terms at £72.4 million.

This contrast mainly reflects a timing issue of inclusion of revenues from Networkers technology recruitment, acquired in early 2015, to complement Matchtech engineering recruitment. Net fee income rose 6% in engineering and 9% in telecoms, but was offset by a 6% fall in the technology business as IT slumped 17%.

Growth opportunities

Yet management views the "Internet of Things" as a growth opportunity within a newly-created engineering technology division, bridging the two sides.

The group is well-placed to benefit from increasing demand for skilled engineers and technology specialists, but there is uncertainty over how the referendum will affect UK investment. After a pause around the EU vote, activity "quickly returned to pre-referendum levels", albeit with "some weakening in UK demand", said Gattaca.

Pronounced weakness in Gattaca shares shows the market pricing in the risk of UK slowdownThree-quarters of revenue derives from approximately one-year contract work, which has more flexibility for challenging times, but isn't as profitable as permanent work. This is shown with first-quarter net fee income guidance forecasting a 3% fall, based on a 2% dip in contract staff and 7% decline in permanent amid UK weakness.

While 95% of group revenue is derived from the UK, international business has grown, with the Americas up 3.3%. The remainder is well spread, unlike PageGroup/Walters, which are substantially more international.

Pronounced weakness in Gattaca shares therefore shows the market pricing in the risk of UK slowdown as it's more exposed to sterling-based revenues compared to some other recruiters. How tough can business get? The crux is whether it's "enough to compromise dividends", as the group says, which implies some sort of slump.

Mind the earnings gap

The difference between normalised and reported earnings has a big effect on the perceived rating, and curiously Gattaca's end-July 2016 results present earnings per share (EPS) only in statutory terms, whereas the Company REFS table charts the normalised trend also.

It's not just an acquisition timing matter: Gattaca's cash flow statement shows annual depreciation/amortisation adjustments rising from £2.7 million to £4.8 million and, typically, with acquisitive "people businesses" you see normalised EPS figures pre-amortisation of goodwill. The 2017 outlook is said to benefit from £3.1 million cost savings from the merger being realised.

'infrastructure' is a speculative theme, albeit one the group can potentially benefit fromManagement reckons it is well-placed to increase UK market share, while pursuing international growth through regional hubs.

The fashion for public infrastructure spending ought to raise demand for engineers, so the stock could respond if Chancellor Hammond's 23 November Autumn Statement fleshes out the bones of fiscal policy.

Heathrow expansion and the Hinkley Point nuclear power station are high-profile examples; right now "infrastructure" is a speculative theme, albeit one the group can potentially benefit from.

Supporting the risk/reward profile

Gattaca has a fairly strong balance sheet unless you want to fuss about intangibles representing 59.3% of net assets, which goes with a people business anyway. Net debt is down 25.6% to £25 million, with a total £32.5 million debt three times covered by £105 million facilities for another four years.

The overall balance sheet strength makes under-pricing more likelyMind that long-term debt has roughly halved and short-term borrowing has doubled, which may mean a higher interest charge, although finance income nearly covered cost this last financial year.

Current assets versus current liabilities work out a comfortable 1.8 times due to £100.8 million receivables, of which £10.4 million are past due payment, but the directors consider fully recoverable.

If the balance sheet were weaker it would justify the market exacting a high dividend yield, but its overall strength makes under-pricing more likely.

Chief executive buys £170k of shares

On 10 August, chief executive Brian Wilkinson he added 47,722 shares at 357p to own 92,722 overall, and the chief financial officer and chief operating officer both increased their net holdings by exercising nil-cost options.

So, at just over 300p to buy, the stock prices in a moderate UK slowdown and offers long-term value on fundamentals: a 400p to 500p range would require a PE multiple of only 10-12 times, yielding about 5%.

Gattaca will continue to face a sentiment challenge if recruitment stocks remain pressured, but an 8% yield should now be a prop.

For more information see the website.

Gattaca - financial summary Consensus estimates
year ended 31 July 2012 2013 2014 2015 2016 2017 2018
Turnover (£ million) 371 409 452 502 618    
IFRS3 pre-tax profit (£m) 8.0 9.9 11.9 11.3 15.1    
Normalised pre-tax profit (£m) 8.0 10.3 12.0 14.0   18.6 19.5
Operating margin (%) 2.4 2.7 2.8 2.9      
IFRS3 earnings/share (p) 23.5 30.7 35.0 29.6 31    
Normalised earnings/share (p) 23.6 32.4 35.1 39.2 38.2 39.4 41.0
Earnings per share growth (%) 19.6 37.1 8.2 11.8 -2.5 3.0 4.1
Price/earnings multiple (x)         7.6 7.4 7.1
Annual average historic P/E (x) 9.5 13.3 17.5 14.7 10.5    
Cash flow/share (p) 27.9 36.0 49.7 49.3      
Capex/share (p) 6.0 3.7 1.2 3.2      
Dividend per share (p) 15.6 15.8 18.3 20.3 22.3 23.2 23.5
Yield (%)         7.6 8.0 8.1
Covered by earnings (x) 1.6 2.2 2.0 2.1 1.7 1.7 1.7
Net tangible assets per share (p) 116 134 156 78.6      
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.


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