Saturday, February 9, 2013

Robert Half Has Upside Potential

There are times in investing when the market does incredibly strange things.  For instance, consider the case of Robert Half International (NYSE: RHI). Its share price was beaten up in Q3 only to surge over 25% since late November. Have economic and employment prospects really gotten that much better since November? Or to put it another way, were they really that bad in Q3?

Robert Half is International is International

I’ve long been interested in how certain bellwether stocks are actually governed by overriding macro-economic movements. With that said there are fewer companies where this applies better than RHI and its employment services offering.

A quick look at revenues for the last quarter shows that US staffing revenues made up 65.5% of revenues, with International staffing at 22.9% and Protiviti (risk and business advice) at 11.6%. In previous cycles analyzing Robert Half really wasn’t that hard. Its main areas of activity naturally followed the global (developed world) economy, which in turn was pretty much synchronized. That’s not the case this time around.
In this graph I have charted
  1. Non-Farm Payrolls data from the Bureau of Labor Statistics (3 month changes)
  2. Gross Margins for Robert Half by quarter
  3. The percentage of revenue from Robert Half’s last quarter divided by the rolling sum of the last four. This is a good indication of an employment recovery

There are a few things to note here.
  • The current employment recovery is similar to previous cycles, but is also disappointing because so many more jobs were lost in the last recession
  • Gross Margins are on an ongoing uptrend and remain indicative of ongoing recovery
  • The revenue metric has turned down a bit lately and is not in line with previous recoveries. I think this is a consequence of worsening conditions in Europe
In short, RHI really is an international company and its international operations are holding things back. But is this good or bad news?

Robert Half's European Prospects

It really is a tale of two regions, with every line of its US business showing sequential growth in the quarter. This trend has continued into January, with RHI declaring that the first four weeks of the year saw permanent placement revenues in the US up 10% and non-US down 28%. The difference in temporary placements is less pronounced, but still comes out as up 5% in the US and down 7% elsewhere.

These numbers are horrible, but the good news is that RHI seems to think that it’s in a bottoming process, as the sequential declines are getting smaller. Moreover, the January numbers above are only for a few weeks. I think the Q1 guidance for revenues of $1.01-$1.06 billion looks a bit conservative and is somewhat reflective of the weakness in Europe. Its mid-point implies revenues to be flat on a sequential basis. With the share price rise after the results it’s clear that the market doesn’t really believe the guidance!

Commentary on Employment Market and the Sector

In general I though RHI’s discussion on the employment situation in the US was quite positive. The Automatic Data Processing (NASDAQ: ADP) report has been indicating that small and mid size companies are hiring, and this is typically a very good sign for the economy. ADP is a much touted ‘employment play,’ but I’m not sure that this cycle will turn out the same for the company. It is facing some strong competition in its business services offering (where it is hoping for growth), and this is a marketplace susceptible to cloud-based competition. ADP recorded 15% growth in its business service and professional employer organization (PEO) services at the last set of results, and I think there is good reason to believe that its mid-single digit full year revenue guidance growth is a tad conservative.

I prefer RHI or something like Intuit (NASDAQ: INTU). The latter has a strong presence in the SMB marketplace and is aggressively expanding its SMB group offerings, and its employment and payment management solutions are growing by double digits. I think the market underestimates the potential for cross selling with the cloud, and Intuit has strong prospects. Its core DIY consumer tax revenue offering generated around 45% of income last year, but its payment, employment, and financial management solutions brought in 34.7% of income, and its rising in the mid teens as opposed to single digits for the consumer tax offerings. Arguably it is the SMB solutions that will guide the direction of the stock.

Two other interesting notes in the commentary were the usual points about how this recovery has been categorized by the determination of employers to hire temps over permanent staff, and acknowledgement of RHI’s desire to move into more technology staffing solutions. An acquisition is always possible in this area, as the company has cash. One company that might fit the bill is a tech-heavy staffing firm like On Assignment (NYSE: ASGN). The stock has doubled over the last year, but it is still not outside the realms of possibility for RHI to take a look. It’s growth rates are hard to find in the industry and its end markets suit RHI's need for more technology exposure.

It's interesting to look at On Assignment's full year outlook in order to see where employment growth is. It forecast 'high 20's' growth in its IT and engineering operation, mid to high teens in healthcare, high single digits for Physicians, and a small reduction in Life Sciences. So IT is doing well, but markets exposed to government funding for academic research are suffering.

Robert Half Stock Analysis?

I don’t like buying stocks after they have been on this kind of run, but I do think there is good potential here. The US employment numbers should be good going forward and RHI’s margins are doing fine. Any sign of stabilization in Europe will act as a growth kicker in the future, and with mid teens earnings growth forecast plus strong cash flow generation RHI can appreciate from here.
My only concern is that the markets appear to be pricing in every rosy scenario right now. And since they reserve the right to change their mind without telling me, I would rather try and buy into RHI on a dip.

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