Edmond Jackson's Stockwatch: Harvey Nash Group

Last June I drew attention to FTSE Fledgling executive recruitment and IT outsourcing share Harvey Nash Group, noting it had been pressured yet the business itself showed resilience; the problem for perception being nearly half of group revenues are derived from continental Europe where it is market leader.

I suggested that if the eurozone muddled through its challenges then at about 50p a share, Harvey Nash likely priced in the risks. It was the classic profile of a cyclical share: the market was wary about earnings variability, exacting a low price/earnings (P/E) multiple - at that time, about 7.5 times the consensus earnings forecast for the year to end-January 2013 - and a generous yield near 6%. Then last December I noted interim results ahead of expectations, although the market remained cautious with the share price advanced only modestly to 57p.

Notice how the market does eventually recognise value, and the perception change can be sudden, if hard to predict when. Harvey Nash advanced to test a low 70p range in the first three months of this year although this was quite what you might expect of a cyclical share in a wider "risk rally". The price then settled back to 67p.

It moved sharply up to 80p, however, ahead of the 30 April preliminary results and also amid a sense the eurozone is currently looking less risky as Italy proves able to form a government. "Austerity" is also becoming a dirty word in European debate. Politicians are seen to be condemning voters, hence there are more expressions towards stimulating growth. Post-results profit-taking has clipped the share price to 74p.

It is interesting to consider the company's progress as recruitment tends to be a leading economic indicator. Harvey Nash has posted a profit increase for the third successive year, despite challenging market conditions, on revenue up 12% to £594.7 million. It notionally suggests that financial markets overdid their gloom in recent years; that despite a recessionary scenario some businesses and consumers can carry on pretty much as usual. However it appears Harvey Nash is benefiting also from an acute skills shortage in new digital and mobile areas. Significant market share gains have also helped.

Gross profit tends to be the main benchmark for assessing recruiters and Harvey Nash's improved by 6% to £83.0 million, albeit explained by a shift in the mix of services in favour of contract and temporary recruitment. It appears management is being adept in the prevailing conditions, between the classic permanent/contract split in a recruiter's service.

Operating profit rose similarly but excluding investment in new offices in Hong Kong, Sydney and Ghent, it increased by 10%. The relatively lower 5% progress in adjusted earnings per share to 8.33p relates to more shares in issue as a result of employees exercising share options. While generally seen as "a good thing" for motivation, employee options are still a cost on shareholders so Harvey Nash's bottom line is only just beating inflation. This may help explain the post-results profit-taking.

Cash generation has been radically transformed, up 269% to £6.7 million, supporting a confident 10% increase in total dividend to 2.92p a share, covered 2.85 times by earnings and representing a prospective yield of just over 4% based on forecasts for about a 10% rise. The dividend has increased consecutively for six years, mitigating the sense of a cyclical share, but the market still emphasises earnings expectations. Despite the re-rating the forward P/E multiple still looks to be under eight times, although watch for updated forecasts.

Geographic performance displays contrasts. Europe accounted for nearly 46% of group revenues, weakness in the Nordics and central Europe contributing to a 2.4% slip for the region. Gross profit slipped by 2% to £38.0 million, but operating profit rose nearly 5%, helped by cost controls and good progress in Benelux offsetting weakness elsewhere. Continental Europe is not proving the quagmire many headlines have implied. Events could yet take a turn for the worse, say if Germany's Constitutional Court rejects the European Central Bank's bond-buying, but the euro continues to survive brinkmanship. Management's adapting towards temporary and contract recruitment has helped, and acquiring Talent-IT in Belgium has resulted in the HVN Benelux business becoming market leader for technology recruitment in the region.

Otherwise the UK and Ireland have shown good progress with gross profit up 9% to £31.2 million, similarly the US up 11% to £11.0 million despite a difficult market with the "fiscal cliff" issues contributing to volatility. Asia Pacific is growing strongly albeit from a small base, in Vietnam and two new offices in Hong Kong and Sydney.

Three independent brokers remain bullish. Panmure Gordon has raised its price target from 66p to 99p after considering the results, Shore Capital reiterated 'buy' on 26 April and Cantor Fitzgerald retains its 100p target. They are effectively anticipating a re-rating of earnings being viewed as less cyclical despite the drop in the 2009/10 year.

So unless the global economy takes a serious turn for the worse - undermining cyclical shares generally - the market's cautious rating of Harvey Nash ought to continue to reward holders.

For more information see www.harveynash.com.