The start of the new quarterly reporting season for recruitment companies provides a good excuse to look at the sector's valuations. Most constituents trade on alarmingly-high ratings that suggest massive earnings growth over the next year or so. But where's the evidence that the jobs market is returning to good health?


It seems that the forward-looking stockmarket is looking well into the future and has already priced in a jobs recovery. So are investors too late to profit from the staffing party?


UK-quoted recruiters: Valuations and earnings growth forecasts

PE (Current FY) PE (Next FY) EPS growth (%) 2013 EPS growth (%) 2014
Robert Walters 29.0 23.3 13.7 24.4
Michael Page 26.4 22.9 7.0 15.5
Sthree 23.1 19.4 14.1 19.1
Hays 19.7 16.9 -11.6 17.1
Source: CompanyREFS

Robert Walters (RWA) kicked off the string of trading updates yesterday (9 Apr) with a muted statement. Its share price didn't move and some analysts shrugged their shoulders, saying the first quarter of 2013 was simply a repeat of trading conditions in the last quarter of 2012. Commenting on the company's outlook, stockbroker Investec says: 'Conditions are steady, but confidence levels are best described as fragile.'


Tomorrow (11 Apr) we will get an insight into trading from Hays (HAS) and Matchtech (MTEC:AIM); next Tuesday (16 Apr) it is the turn of Michael Page International (MPI).


Investec published a detailed note on the recruitment sector in February. It says any investment decision in the sector is based on a macro call. 'Whilst we aren't in a normal economic cycle, recent trading suggests we may be near the bottom,' it writes. 'History would support the view that this is a good time to rotate into the sector; and the sector has indeed performed well of late. However, we think the road to recovery will be long and bumpy, calling for a more selective approach.'


Robert Walters is trading on the highest rating for the current financial year of the largest quoted peer group. Consensus forecasts put the recruiter on 29 times earnings for 2013, as illustrated by the table above. Yesterday's trading statement wasn't good enough to trigger widespread earnings upgrades but 4% growth in net fee income could be seen as a pleasant surprise. Yet net cash was poor because of a rise in temporary assignments, which puts pressure on working capital as agencies tend to pay candidates before they get money back from the client.


RWA - Comparison Line Chart (Rebased to first)


Stockbroker Panmure Gordon reckons that the recruitment sector in general 'looks ahead of the game and over-valued' and it has a 'sell' rating on Robert Walters. We agree with its comments that there is 'sparse evidence' of any sustained improvement in markets or prospects. Panmure Gordon does, however, believe that the UK looks more stable and over the worst.


Numis says Robert Walters' rating looks up with events in the short-term, ahead of clearer signs of sustainable recovery.


As we wrote in February (click here), shares in staffing agencies enjoyed a good start to 2013 as investors grew more confident about global economic prospects. We noted that Robert Walters had lagged its peers and a lack of dividend growth at the finals two months ago didn't help its cause. While it subsequently caught up, the broader sector rally has now stalled, putting the high valuations into question.


Some analysts remain selectively bullish, particularly David O'Brien at Shore Capital who recently upgraded his recommendation on SThree (STHR) from 'hold' to 'buy' in the belief that we are at the beginning of a 'classic' recovery in net fee income levels. He also upgraded Robert Walters yesterday from 'hold' to 'buy', saying: 'The recommendation upgrade is in spite of the high valuation relative to most peers, as when recovery begins to feed through upgrades generally follow.'


The big question for sector heavyweight, Michael Page, is whether investors are prepared to pay 26 times forecast earnings for 2013 where earnings per share are only expected to nudge ahead by 7%. It has only been five months since it issued a profit warning, and has the world really changed since then? That warning was also its second in less than a year.


MPI - Comparison Line Chart (Rebased to first)


As we have regularly discussed in Shares, stocks on a high rating can fall sharply on the slightest bit of negative news. This is something that any investor in the recruitment sector must always remember.


We are not completely bearish on the recruiters; indeed some of the smaller companies trade on much lower multiples and have niche positions which could prosper in times when mainstream job availability is muted. One of the stocks recently highlighted in Shares is Interquest (ITQ:AIM) which trades on 12 times forecast earnings for 2013, less than half of Michael Page's rating. Click here to read a story we wrote on the stock last month.

Issue Date: 10 Apr 2013