One of the things I like about the stock market is that it tells you what’s really going on in the world.
A market where millions of people invest their own money is always going to be a better guide to the future than any economic forecaster or government expert. I’ve taken the strength of equities over the last few years as confirmation of my view that things are a lot better than many pundits would have had us believe.
I was amused to read that the Office for National Statistics is to adopt new techniques to measure the economy. These are expected to result in an upwards revision to the growth achieved by the UK over the last two years. Which is all very reassuring, but it seems a lot of effort to confirm something we already know.
The stock market could have already told you that Britain is set to record the fastest growth of any G7 country this year, and that over the last two years, the number of people in work has risen by a million. The workforce now stands at a record 30 million. And hiring all those workers is a big business in itself.
Today, I want to talk about a company which is right in the middle of this hiring boom. The chairman has already had huge success in the recruitment industry – his previous company earned investors a tenfold return. It’s currently trading well, and, most importantly, it’s managed to sidestep one of the biggest problems facing recruitment companies today.
During a recovery, recruiters make outsized profits
Recruitment companies have high operational gearing because their cost bases are relatively fixed, while their revenues are variable. During downturns, they suffer badly when their clients aren’t hiring staff; and during a recovery the profits can come through very sharply. Analysts usually underestimate the extent of this operational gearing, so you often get a long period of upgrades to forecasts during the recovery phase of the cycle.
The all-knowing stock market realises this; so most of the leading recruitment consultancies are already trading on high forecast price/earnings (p/e) ratios. For example, Michael Page is on a p/e of 26 for this year and 21 for 2015. The numbers for Hays are similar. The market is discounting some upgrades, therefore; but I still think these stocks can do well.
If you look among the smaller stocks, some more obvious value emerges. One that interests me is InterQuest (ITQ) which was founded in 2001 by Gary Ashworth. Gary is a recruitment industry entrepreneur for whom ITQ represents the second time around. He originally set up Abacus Recruitment, floated it on Aim in 1995 and sold out in a cash bid which made his initial investors a tenfold return. After spending a couple of years away from the fray, he returned to repeat the process with InterQuest.
It was a ‘buy-and-build’ strategy, which saw the business listing on Aim in 2005, only to be affected by the recession. Two important sectors for ITQ are banking and government – which were the industries hit hardest by the financial crisis. This has required some retrenchment. Costs have been cut, operational management changed and the business has been rebranded as a single entity. Together with its specialism in supplying technology staff, this has allowed ITQ to outperform the industry last year.
The ‘LinkedIn problem’ – and how ITQ avoided it
Two thirds of the group’s fees come from 1,500 contractors who typically work on six to nine-month long assignments. In recent years, there’s been a sustained shift to contract working, especially in the tech industry. Employers like the flexibility; and there’s no longer any stigma attached to being a ‘temp’ as people enjoy more varied careers. The permanent market is more volatile than the contract market; but there are signs that it’s improving. The contractor fees cover ITQ’s costs, so permanent placement revenue represents pure profit. I would expect this profitable permanent market to pick up strongly as the economic cycle matures.
These days websites such as LinkedIn can undermine recruitment consultants. HR departments can use social media tools like this to get direct access to candidates, especially in easier-to-fill roles. To guard against this and go up the value chain, ITQ has focused on the specialised growing areas of digital, enterprise software, and telecoms. It’s developed an expertise in these areas, providing advice and recruits for clients in the finance, government and retail sectors. Big Data and business analytics, which require ITQ’s know-how, are ‘hot areas’ for recruiters at the moment.
So the market is clearly picking up and InterQuest is performing well after its re-focusing. Broker forecasts have the shares on a modest p/e of 12.6 this year, falling to 9.9 in 2015; but these could be beaten as operational gearing kicks in. There is also a yield of 2.5% which helps.
But there’s another factor that adds further interest to the shares. The management team owns around 42% of the stock with chairman Gary Ashworth having a 37% stake. He has been quite open about the prospect of selling the company at some point in the next few years. With the cycle moving his way again, this ‘exit strategy’ would seem to be a viable plan. After all, he did it before with Abacus – let’s see if he can do it again.