Robert Half International Earnings Analysis

The world's largest specialized staffing company, Robert Half International  (NYSE: RHI  ) , delivered a broadly positive set of fourth-quarter earnings on Thursday. In addition, management's commentary alluded to a tangible and positive shift in employment conditions. particularly in the U.S. As such, the company has entered the year in good shape, and the recent results contained many useful indicators of what its end markets could be like in 2015. Let's take a look at them in more detail.


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Robert Half International Earnings Review

Staffing services company Robert Half International (NYSE: RHI  ) beat analyst estimates for the third quarter and delivered guidance ahead of the Wall Street consensus for the fourth quarter. In an act of almost prescient behavior, the market took the stock more than 5% higher before the results. However, all of these short-term movements shouldn't trouble long-term investors unduly, as the positive drivers behind the stock remain in place. Robert Half is set for continued growth, but what about its valuation?



Robert Half International tops estimates
A quick look at the earnings and guidance versus consensus analyst estimates confirms tht the underlying trends in the business remain strong:

• Third-quarter revenue of $1.22 billion, versus estimates of $1.2 billion.
• Third-quarter EPS of $0.63, versus estimates of $0.58.
• Fourth-quarter revenue guidance of $1.175 billion to $1.225 billion, versus estimates of $1.2 billion.
• Fourth-quarter EPS guidance of $0.57-$0.62, versus estimates of $0.58.

Moreover, commentary on the trends in the third quarter and the first few weeks of the fourth were positive. The following table summarizes what management disclosed on the conference call.


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On Assignment, Kforce and Robert Half Look Set to Outperform

Despite some of the doom and gloom in the press, the economy is slowly recovering and investors are being rewarded for buying cyclical stocks. As such, staffing companies look like a good place to be invested. Not only is the economy helping the likes of Robert Half   , but there are some secular growth trends helping, too. In particular, a technology specialist like On Assignment   is managing to grow in excess of its marketplace, and looks well placed for future growth.

Two reasons why staffing is a favorable market
First, the economy is seeing a cyclical recovery in employment. While most observers focus on payroll numbers, the American Staffing Association also issues an index of temporary and contract staffing. Fortunately, the data indicates that 2013 is set to be the best year since 2007.

Source: American Staffing Association

Second, while increases in the staffing index have historically led to a pickup in permanent employment, there are sectors in which temporary staffing looks likely to be stronger than it has been in previous cycles. In particular, staffing companies operating in the science, technology, engineering and mathematics, or STEM, marketplace are likely to benefit from favorable trends.

For example, on its conference call, fellow IT staffing company Kforce's   management quoted data demonstrating that the percentage of temporary workers as a share of the labor force rose to 2.02% in the third quarter (a figure significantly "higher than last cycle's 1.96% peak").

Technology cycles are getting shorter, so corporations are more likely to hire in staffers. Additionally, according to the management of On Assignment on its conference call, companies like Accenture may be susceptible: "We're not saying that we're beating Accenture at project consulting. We're saying that the customer is deciding more often than not now that maybe they should do this on an IT staff aug basis, versus a project consulting basis."

Furthermore, if the skill sets required in STEM employment are becoming increasingly differentiated, companies will be more inclined to carry out a project by drafting temporary workers, instead of executing it internally. It takes a lot of time and money to train staff with new skills.

Staffing companies generate strong cash flows
In addition to favorable trends, staffing companies tend to convert profits into cash flow very well, and in bad times, the conversion rates tend to rise.  

Note that in the following graph, the free cash flow calculation is simply reported operating cash flow minus capital expenditures. The quoted companies may report this metric differently.

Source: Google finance, author's interpretation

On Assignment is the best pure play STEM staffing company. It competes with Kforce and the technology division of Robert Half, and all three companies look set to deliver strong performances this year.

In its latest third-quarter results, On Assignment delivered consolidated revenue growth of 15%, with Apex (a mission-critical IT staffing company acquired in May 2012) generating a 22% increase, and Oxford (a high-end IT and STEM company acquired in 2007) generating a 14% increase. Apex and Oxford made up 80% of On Assignment's revenue in the quarter, and management predicts fourth-quarter revenue growth of 12.8%-13.8%.

In comparison, Kforce's technology unit, called Tech Flex, represents around 63% of revenue, and it grew at a healthy 14.2% in its last quarter. Kforce's total company revenue is expected to grow by 12% in the quarter. Robert Half is more of an all-purpose staffing and recruitment company, and its technology segment only makes up around 12.3% of the company's total revenue. Nevertheless, recent results confirmed the trends discussed above, with Robert Half's technology revenue growing at 11.8% in the quarter, versus only 2.5% for the total company.

Kforce, On Assignment, or Robert Half?
The staffing industry is in good shape, and all three are forecasted to substantially grow earnings next year. If you are looking for international exposure across a range of industries, Robert Half's valuation of 17.9 times forward earnings should be attractive.

Foolish investors who prefer more of a STEM focus will be guided toward On Assignment, especially as it's forecast to grow earnings by 19% in 2014. The stock trades on a valuation of 22.6 times forward earnings.

Meanwhile, Kforce's growing technology segment is expected to lead the company toward $1.17 in EPS next year, putting it at 16.9 times forward earnings. All three tend to generate significant free cash flow in excess of profits, and they all look like good potential purchases for the cyclical end of your portfolio. 

Robert Half Weak Outlook?

Robert Half gave a mixed bag of results. I always believe in telling it like it is and, frankly, I think the stock will be down tomorrow. However, I don't things are as bad as the market might take them and any decline could create a decent buying opportunity. I've previously written about Robert Half here and focused on its correlation with strong employment gains in a recovery. The metrics cited in that post continue to improve.

However, in this post I want to talk about the specifics of these results.

Reported

• Q4 Revs of $851.6m vs. $831 estimates
• Q4 EPS of 17c vs. 16c estimates

Guidance

• Q1 2010 Revs of $850-900m vs. $836.2m estimates
• Q1 EPS of 13-18c vs. 18c estimates

Robert Half Q4 2009 Results

They beat handsomely on revs and income but I suspect the market isn't going to like the mid point of  Q1 guidance being below analyst estimates. Whichever way I look at it, I can't conclude otherwise. Margins look to be lower than analysts had forecast and, many of the questions on the conference call focused on the reasons for this.

Answering analysts questions on the subject of margins for Q1, the board mentioned the following

1. State unemployment tax rates are expected to increase at the same rate in 2011 as in 2010, so a 50-75bp reduction in sequential temp gross margins for Robert Half
2. Protiviti seasonality will result in a sequential 10% decline in revenues. This is at the midpoint of what they traditionally lose in this quarter.

Now given that, temporary and consultant staffing comprises 83.5% of operating income the forecast reduction in gross margin is significant. The Protiviti seasonality issue should be well known.


Conservative Guidance?

Robert Half estimates that State unemployment taxes will grow at the same rate as in 2010 (75bp hike) and ultimately your view on this guidance will depend upon your outlook for growth. Faster growth rates engender greater tax revenues and less need for tax hikes and they also bolster debt servicing abilities.

 I don't consider it apposite to 'second guess' Robert Half on this but merely point out the upside should the US continue on its accelerating growth path. They had this issue last year and it took them a while to recover, so perhaps they are being unduly conservative.

Moreover, looking at Robert Half guidance history for EPS (cents)...

 

	Q4 2009	Q1 2010	Q2 2010	Q3 2010	Q4 2010	Q1 2011
Market Estimate	5	6	7	13	16	18
Co Guidance	1 to 6	3 to 8	3 to 8	9 to 14	12 to 18	13 to 18
Actual	9	5	8	14	17
Actual/Co  %	160	40	100	100	83

....suggests that they tend to be conservative. In the last row, any number above 50% indicates that the actual result was above the midpoint of guidance. Nonetheless, the Q1 2011 guidance looks light.

It is a similar story with Revenues (m)


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	Q4 2009	Q1 2010	Q2 2010	Q3 2010	Q4 2010	Q1 2011
Co Guidance	675 to 725	725 to 775	730 to 780	770 to 820	800 to 850	850 to 900
Actual	737	737	769.1	817.3	851.6
Actual/Co %	124	24	78	95	103

Robert Half Q1 earnings may well hit the high end of their guidance, particularly as employment gains look highly probable for the US economy, but I think the time to pick up the stock will be around then. I expect analysts to downgrade forecasts after this outlook.



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Robert Half Set to Continue Gains?

Robert Half International RHI is an interesting stock to look at because its earnings and –more importantly- its share price drivers and prospects tend to reflect macro-economic concerns rather micro. It is a very cyclical stock. Analysts waste a lot of time trying to analyze the finer detail of Robert Half’s numbers and execution, but in reality it is the employment environment that governs its prospects.

Having noted that, it is worth noting that this doesn’t preclude individual company analysis of Robert Half. Rather, it means that an analysis should focus on the macro-economic direction (employment gains) and then appraise prospects based on the performance of their execution. For example, the following data is a good example of how cyclical this stock is.

The first column represents a metric to analyze the turning point in Robert Half fortunes. The quarterly revenue is divided by the rolling yearly revenue. The second column is the quarterly Gross Margin. The third is the private non-farm payroll net 3-month, taken from the Bureau of Labor Statistics.

The green number represent bottoms or troughs, whereby the direction afterwards is upwards. Similarly, the red numbers are tops or peaks.

	Quarter Rev as percentage of Rolling Year Revenue	Quarter GM	Private Non-Farm Payrolls 3 Month Net
2000	0.00%	42.83%	649
q2	0.00%	43.13%	311
q3	0.00%	42.92%	440
q4	26.15%	43.11%	289
2001	25.82%	43.24%	-126
q2	23.44%	42.04%	-645
q3	21.71%	40.13%	-634
q4	20.82%	39.61%	-908
2002	21.28%	39.47%	-379
q2	23.34%	38.70%	-165
q3	25.03%	36.18%	-165
q4	25.12%	35.79%	-64
2003	24.78%	35.85%	-309
q2	25.16%	36.73%	-53
q3	25.88%	37.34%	188
q4	26.21%	37.21%	303
2004	27.59%	37.74%	489
q2	28.73%	39.71%	628
q3	29.03%	39.87%	294
q4	28.19%	40.21%	489
2005	26.80%	40.75%	471
q2	26.79%	41.18%	752
q3	27.03%	41.06%	545
q4	26.50%	41.47%	542
2006	26.87%	41.66%	869
q2	26.70%	42.57%	262
q3	26.76%	42.06%	336
q4	26.42%	42.55%	384
2007	26.33%	42.00%	478
q2	26.52%	42.88%	234
q3	26.29%	42.48%	-108
q4	26.26%	42.92%	185
2008	25.68%	41.68%	-155
q2	25.25%	42.19%	-644
q3	24.03%	41.65%	-1060
q4	21.51%	40.65%	-1948
2009	19.61%	35.67%	-2257
q2	20.14%	35.34%	-1435
q3	22.07%	36.70%	-698
q4	24.28%	37.77%	-270
2010	24.98%	36.51%	236
q2	25.90%	37.69%	353
q3	26.70%	37.82%	372

Source: Robert Half,Bureau of Labor Studies, Earnings View


The key is to note how closely correlated Robert Half's cyclical fortunes trough with a bottom in private non-farm payrolls. However, it is worth noting that Gross Margins continued to rise, right up til the employment market turned with the recession in 2008. In fact Robert Half's share price did well (although there was some stock specific weakness in mid 2006) right up until the start of 2007.

All of which indicates that there is probably more to run from Robert Half in terms of Gross Margins, share price and profits. However, it appears that Robert Half's share price is far more dictated by the direction of employment gains/losses than an underlying current profitably. If you think the economy will continue to improve in 2011 and payroll gains will remain positive than RHI has further to run.