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.

H & R Block a Structurally Challenged Business?

H & R Block HRB gave results on Friday and they appear to be confirming my feeling about this company. I think they are company that benefits from a cyclical upturn in employment (employees filing more tax returns) but who are structurally challenged by rivals such as Intuit.

In a sense H & R Block is the archetypal Warren Buffet type of stock. Indeed, he has formerly held large stakes in this company. It has a strong market position, holds a good competitive boat and generates lots of cash flow. A classic Warren Buffet ‘annuity’ type of stock, whose position in the heartland of America (via opening stores in Wal-Mart and such like) is assured. However, technology is no respecter of tradition or of Warren Buffet.

Intuit’s (do it yourself software based solution) has been eating into market share. Furthermore, the pick up in employment in this recovery-so far- has been noticeably behind previous recoveries. Moreover, employment gains have not yet compensated for the losses in employment during the recession.

So we have a business that is structurally challenged. They look set to benefit from a cyclically pick up, but I would prefer more pure plays on economic recovery than H & R Block.

New Drugs in Development for Rheumatoid Arthritis

I decided to take a look at which new drugs and treatments were in development in order to treat Rheumatoid Arthritis. There are a number of small molecules in development and it is noticeable how Janus kinase (JAK) inhibitors seem to dominate the landscape. Quite a few companies listed on the stock market are developing new drugs for Rheumatoid Arthritis.

TNF Blockers

Unlike TNF blocker biologics like Humira (injected on alternate weeks) Enbrel (injected once a week) or Remicade (intravenous every month or so), these drugs (kinase inhibitors) tend to be taken orally. The three afore mentioned TNF blockers are responsive in 70% of patients, including some who do not respond to the first line treatment of methotrexate. They are expensive and have significant side effects.

JAK Inhibitors for Rheumatoid Arthritis

Janus kinases are receptor associated kinases that provide a pathway for the cytokines that are seen as playing a pivotal role in inflammation of the joints for the Rheumatoid Arthritis sufferer. Of the four JAKs that have been discovered JAK3 has attracted the most attention because it doesn’t seem to have actions outside of hematopoietic cells. I’ll go into more detail on the individual programs below. For reference, the other three JAKs are JAK1, JAK2 and TYK2.

New Drug Pipeline for RA

Company	Compound	Action Inhibitor	Timeline
Lexicon	LX2931	SP1L	Phase IIa ,top line results due by end 2010
Pfizer	CP 690,550	JAK 1/3	Completed Phase III. Four more studies before FDA submission in 2011
Galapagos	GLPG0259	MAPKAPK5	In Phase II, interim results due Q2 2011, top line Q4 2011
Vertex	VX509	JAK 3	In Phase IIa, results due 2011
Morphosys	MOR103	GM-CSF	In Phase Ia/IIb, final results due H1 2012
Incyte/Eli Lilly	INCB28050	JAK 1 / 2	Phase IIb begun in late 2010
Rigel/AstraZeneca	R788	SYK	Phase III begun in late 2010

Pfizer’s CP 690, 550  Tasocitinib

Pfizer’s CP 690 (tasocitinib) is in Phase III for both Rheumatoid Arthritis and Psoriasis. They recently gave Phase III results in Rheumatoid Athritis and it was claimed that CP 690 reduced inflammation in 71 percent of patients. Tasocitinib is an oral indication taken on a once a day regimen. According to the Reuters article

“On the study's first primary goal, 65.7 percent of patients who received 10 milligrams of tasocitinib twice a day achieved ACR20, meaning at least a 20 percent improvement in disease activity and symptoms, after three months of treatment. Nearly 60 percent of 5 mg patients reached ACR20, compared with 26.7 percent of those who received a placebo, researchers said.”

This would appear to be the leader here and Pfizer are developing tasocitinib for other inflammatory diseases such as ulcerative colitis, psoriasis, and Crohn’s disease. FDA submission could take place for RA in 2011.

Interestingly, a study was carried out in 2010 (Cohen) which demonstrated that there weren’t any clinically significant effects on the pharmacokinetics of either drug, if they were taken together. Therefore, there would be no dosage adjustment if taken together.

Rigel/AstraZeneca R788 Fostamatinib Disodium

R788 was in licensed by AstraZeneca early this year in a deal that is potentially worth $1.25bn. This was seen as a significant sign of approval for a drug that had failed one of three Phase II studies in 2009.  R788 or Fostamatinib Disodium is an orally taken (twice a day) SYK inhibitor. Despite the setback in 2009, they reported superb results in a six month Phase IIb study this year. According to Rigel

  “  - The ACR 20 response was achieved by significantly more patients in both the fostamatinib 100mg bid group and the fostamatinib 150mg qd group (67% and 57% respectively) than the placebo group (35%, p<0.001).
- The ACR 50* response rates were 43%, 32% and 19% for the fostamatinib 100mg bid group, 150mg qd group and placebo group respectively (p<0.01). The ACR 70* response rates were 28%, 14% and 10% for the fostamatinib 100mg bid group, 150mg qd group and placebo group respectively (p<0.001 for fostamatinib 100mg bid, p=0.34 for fostamatinib 150 mg qd)
- In addition, the DAS 28 remission rate was significantly higher in both the fostamatinib 100mg bid group and the fostamatinib 150mg qd group (31% and 21% respectively), compared to the placebo group (7%, p<0.01).”

Furthermore, 36 percent of patients achieved ACR20 after just one week, so these phase IIb results demonstrate that R788 has a faster mode of action than Pfizer’s CP 690. Furthermore, remission was statistical significant and this was something that Pfizer could not achieve in Phase III. 

Side effects included increased risk of diarrhoea and hypertension. Phase III trials will begin in late 2010.

Lexicon LX2931 

LX2931 inhibits sphingosine-1-phosphate  (S1P) lyase, which is an enzyme seen as being on a path to regulating the immune system. They’ve demonstrated-in pre-clinical- that inhibiting S1P has reduced inflammation in mice, however the Phase IIa trial is a 208 patient trial. What’s interesting about LX2931 is that it is intended as a combination therapy with methotrexate and is being trialled in this manner. Top line data is due by end 2010.

Incyte/Eli Lilly INCB 28050

Incyte has two JAK inhibitors in development. Its lead compound is INCB18424 which is in Phase III for myelofibrosis and Phase II for polycythemia and psoriasis, respectively.  INCB28050 is its JAK 1 / 2 inhibitor for RA. Eli Lilly paid $90m initially for this compound, with Incyte being eligible for $655m in milestones, as well as royalties on top. They recently presented results for a six month Phase IIa trial

“all three doses of oral INCB28050 (4 mg QD, 7 mg QD and 10 mg QD) improved on the primary endpoint, the percent of patients achieving American College of Rheumatology (ACR) 20 improvement, over the full 24-week treatment period. Importantly, ACR responses improved between week 12 and week 24 achieving up to 72% for ACR20, 44% for ACR50 and 30% for ACR70 at week 24. Results seen at 12 weeks for placebo were 32% for ACR20, 13% for ACR50 and 3% for ACR70, and for patients treated with INCB28050 the results were up to 59% for ACR20, 35% for ACR50 and 16% for ACR70.”
As with Rigel’s R788 adverse effects of diarrhoea and hypertension were reported. Eli Lilly plans to begin Phase IIb shortly. 

Vertex VX509 JAK3 II

I’ve previously discussed Vertex here but omitted to mention VX509. VX509 is a JAK3 inhibitor that Vertex has in a Phase IIa 200 patient proof of concept trial. Interim clinical data is expected in 2011.

Galapagos GLPG0259

Galapagos is another company I mentioned recently and MAPKAPK5 (a protein kinase) was discovered as playing a role in RA, via Galapagos’ proprietary discovery technology. It is a good illustration of their business model. Galapagos feel that it is involved in signaling a pathway to inflammation. GLPG0259 is orally taken, once a day regimen, and is compatible with methotrexate. Indeed, the initiated Phase II will be with methotrexate. Interim results are due in H1 2011 and top line results by end 2011.

Morphosys GSM-CF Inhibitor MOR103

I wrote a bit about MOR103 here and what makes MOR103 a novel antibody, is that it targets GM-CSF, which is seen as an inflammatory mediator that activates the JAK pathway. It is currently in Phase Ib/2a trial, with final results due in H1 2012.

Conclusion on New Treatments for Rheumatoid Arthritis

This new collection of drugs represents a potential improvement to the TNF blockers, in terms of regimen and side effects. Pfizer’s CP 690 is the leader and appears to be a blockbuster in the making. It should be well established by the time that Incyte and Vertex get their JAK inhibitors on the market. Pfizer’s is the only compound successfully through Phase III. Rigel’s R788 is very interesting due to its speed of action and efficacy, however this is yet to be confirmed in Phase III and it will be a while before they complete this. 

Lexicon and Galapagos present options for combination with the first line treatment of methotrexate. GLGP0259 is in early stage, but Lexicon’s LX2931 should give results soon in a Phase II trial. Morphosys MOR103 is early stage but potentially a blockbuster as they own the rights to GSM-CF inhibitors in inflammatory diseases in the US. I opened a small speculative position in Lexicon ahead of their Phase IIa data in LX2931.

Source:

Cohen S, Zwillich SH, Chow V, Labadie RR,Wilkinson B “Co-administration of the JAK inhibitor CP-690,550 and methotrexate is well tolerated in patients with rheumatoid arthritis without need for dose adjustment."  British Journal of Pharmacology, Volume 69, Issue 2, Pages 143-151, February 2010

Reuters “Pfizer Arthritis Drug Succeeds in Late Stage Trial”

Rigel Website (accessed Dec 2010) “Data Published Today Reveal That Novel Oral Therapy Fostamatinib Demonstrates Positive Response in Rheumatoid Arthritis Patients”

Incyte Website (accessed Dec 2010) “Incyte's Selective Oral JAK1 and JAK2 Inhibitor Demonstrates Positive Phase IIa Results in Patients with Active Rheumatoid Arthritis” 

SQS Software Quality Systems Trading Update Should Lead to Analysts Upgrades

SQS Trading Update

SQS Software Quality Systems AG gave a trading statement today. They style themselves as the world's largest pure play supplier of independent software testing and quality management services. I think this is an attractive market to be in because IP (and embedded software) is becoming an ever increasing part of a typical goods value. Therefore, software testing services should be able to grow at a faster pace than IT services in general. I should note that this is a German company but it is listed in the UK market. They report in Euros, so be careful when looking at analyst forecasts.


SQS Managed Service Contracts

The last point alludes to the fact that SQS is still a cyclical play and indeed, they were hit in 2008-09. However, the strategy of the company has been to try and move towards managed service contracts and away from purely project work. The problem with the project work is that it is short term and visibility is low. It therefore leaves SQS to be exposed to the cyclical nature of the economy and to suffering from having consultants under utilised.

Unfortunately, in 2008 they underwent an expansion in consultants at precisely the time when their end markets turned down. They learnt the lesson and, are now moving towards manged services as well as increasing the portion of their staff in offshore (lower cost) centres. It seems to be working...

The Company has recently won three new Managed Services contracts and extended three existing ones, such that order intake for the Managed Services division has exceeded €50 million in the year to date. A Managed Services contract can be expected to provide improved visibility of earnings and enhanced margins, compared to a traditional project, over the entire life cycle of the engagement, although it may involve lower margins in the initial phases as the majority of work is carried out by onshore consultants during this time.

...and this is a good update. SQS trades at a share price of 195p and a £53m market cap which-according to analyst forecasts- puts it on PE ratio of 10.3x and 8x for 2010 and 2011 respectively. I think that analysts will have to raise forecasts after this update, however a trading update is due in January.


Catalysts for a Re-Rating

There a catalyst for a re-rating due to a reduction in risk due to taking on more longer term managed services contracts. Furthermore, on evaluation grounds it is clearly undervalued. However, investors maybe overlooking the potential for some M & A activity. The management hold the stock tightly, but it's attractions to a bidder are obvious.

Firstly, it provides a high growth niche area of IT services. Secondly, for an Indian IT services company, it would present an ideal way to add scale in Europe and they should be able to increase margins by shifting work to their staff in India. Thirdly, the evaluation is compelling.

I hold a position.

Begbies Traynor A Counter Cyclical Share that Benefits from Recession

Begbies Traynor is an interesting business to do a bit of equity research on. What makes it an attractive stock, is that it is an insolvency practitioner and should give counter cyclical growth. In other words, it is a nice way to balance your portfolio. Furthermore, over the years they have been making acquisitions and consolidating in order to achieve growth. They gave a trading statement a few days ago..

"As a consequence of this, together with an increase in finance costs resulting from the Group's new banking facilities, we expect adjusted pre-tax profits* in the first half year to be around £0.7m below last year's results of £4.3m. Following some restructuring undertaken in the period, exceptional costs of approximately £0.8m have been incurred in the half year."

Frankly, this sort of thing no longer surprises me about Begbies Traynor. Whilst, they were a great counter cyclical stock to buy in 2008, their management has-in my humble opinion- a bit of a patchy record. I'm not trying to do a 'hatchet job' here but rather analyse how best to view this company and trade it. I've held this stock before (in 2005) and was amazed to look at it again and, see that it is back to the price that I had paid for it in 2005.

In 2005, Begbies Traynor was a recently listed stock that was acquiring private practitioners and consolidating them. The investment proposition was compelling because you got growth through earnings accretion plus upside potential from a slowdown in the economy. It is easy to see how this would balance the portfolio. It worked. The share price went on to tough the dizzy heights of 200p although I was long since out by then.

However, since 2006, BEG seemed to lose their way.  During 2006 the UK economy progressively got better and as a consequence liquidations fell. As liquidations fall, so the pipeline of insolvency practitioners will fall too. Perhaps as a consequence, they expanded their corporate finance activities, in order to balance the future slowdown in insolvencies. However, the commentary in their trading statement of Oct 2006

"The directors are, therefore, unaware of any reason which would explain the recent downward trend in the market price of shares in the company."

suggests the management are a bit 'out of touch' with what moves share prices. If insolvencies are falling, so should the prospects for listed insolvency practitioners. It's not rocket science. See the downward move in 06-07 here


                                                               Compulsory            Creditors

Liquidations            Voluntary

                                Total                                                     Liquidations                           

2000                14,317            4,925                 9,392

2001                14,972            4,675               10,297

2002                16,306            6,231               10,075

2003                14,184            5,234                8,950

2004                12,192            4,584                7,608

2005                12,893            5,233                7,660

2006                13,137            5,418                7,719

2007                12,507            5,165                7,342

2008                15,535            5,494              10,041

2009                19,077            5,643              13,434

 source: http://www.insolvency.gov.uk/otherinformation/statistics/201011/table1.pdf, figures are not seasonally adjusted


Begbies reacted to this by increasing their corporate finance arm. It wasn't enough and the inevitable profit warning came in Dec 07

"Despite an anticipated stronger second half, we cannot be confident that the profit shortfall from the first half will be recovered. Consequently, the board currently considers that the Group's operating profit for the full year to 30 April 2008 may be 20% below that reported for the prior year."

bundled with the confirmation of a slowdown in the once booming IVA market for them. The share price got back down to 87p. Of course, this then proved an opportune time to buy as the credit crunch hit and the recession provided them with good opportunities. See table above.

The share price recovered to nearly 200p at the time of the height of the credit crunch in Autumn of 2008. Since then, it has been downhill all the way, as the economy recovered...

Table I. Company Liquidations in England and Wales (seasonally adjusted)

                                                                                                                                                            

                                                                                                                                             %Q3 2010               

                                                      2009 Q3    2009 Q4    2010 Q1    2010Q2 r     2010 Q3 p       Q3 2009     Q2 2010 

Company Liquidations                     4,615           4,457        4,060         4,063           3,974                 -13.9           -2.2
of which: Compulsory                       1,289           1,331       1,298          1,164           1,126                 -12.6           -3.2

               Creditors’ Voluntary2         3,326           3,126       2,762          2,899           2,847                 -14.4           -1.8

source: insolvency.gov.uk

All of which leads us to the recent warning. So is this a good time to buy and, what can we learn from this?

I think it is better to focus on the overlying economic fundamentals and the insolvency data, rather than the managements statements. They do try and mitigate the macro drivers but it has proved to be a mistake to rely to much on their commentary. Similarly, I wouldn't take their 'Red Flag Alert' monitor too seriously, when making an investment decision over Begbies Traynor.

 History shows us that insolvencies were in an uptrend in 2008 and you would have made good returns by waiting for an uptick in this metric before buying the stock. This is a stick to monitor, and this may prove an opportune time to buy, but I think it should be on monitor for now.