| 2023 | 2024 | ||||||
| Price: | 79.75 | EPS | 5.29 | 0 | |||
| Shares Out. (in M): | 109 | P/E | 15.1 | 0 | |||
| Market Cap (in $M): | 8,653 | P/FCF | 0 | 0 | |||
| Net Debt (in $M): | -593 | EBIT | 0 | 0 | |||
| TEV (in $M): | 8,060 | TEV/EBIT | 0 | 0 | |||
| Borrow Cost: | General Collateral | ||||||
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I am recommending Robert Half (“RHI” or the “Company”) as a short with at least 20% downside. Robert Half is a leading global specialty staffing firm with a strong, long-term track record but the Company operates within the cyclical staffing service industry and there is much evidence that cyclical employment pressures, part of which is the Federal Reserve’s (“FED”) desired outcome, are likely to intensify. In addition to cyclical pressures, I also believe there are some secular issues that are not adequately discounted. Consensus EPS for 2024 envisions a rebound after an estimated EPS decline of ~12% in 2023 from 2022. I think that will prove too optimistic when the FED is expecting (and orchestrating) an unemployment rate that will be at least 100 basis points higher by year-end versus the recent 50-year low. Moreover, RHI is already witnessing challenges as described during their Q3 earnings call from a broad-based slowdown in the pace of client hiring, especially among its core SMB clientele, a longer sales cycle, and more stringent hiring requirements. Relative to its peer group, RHI trades at ~20% premium on a EBITDA multiple basis and ~15% premium on a P/E basis.
For some historical context, one can review the three RHI postings to VIC since 2008. This will be my second time posting RHI as a short to VIC. When I posted the idea at $20 during the Great Financial Crisis (“GFC”) in December 2008, I suggested a target of $14. RHI bottomed on March 6, 2009 at $14.06. I have higher conviction pertaining to shorting RHI today versus during the GFC since the FED initiated quantitative easing during November 2008 and lowered its rate to 0-0.25% in December 2008. The economy and market are now confronting quantitative tightening from an unprecedented magnitude of quantitative easing compounded by the fastest increase to rates from the FED. I think it is unlikely that QE will be announced in the near-term absent a severe setback to the economy and/or market. This would most likely be predicated by a more significant decline to RHI than 20% as such a “pivot” would partially be driven by the FED focusing on its employment mandate as opposed to its prioritization of its inflation mandate.
When I posted RHI as a short during the GFC, the VIX was almost 60 versus around 20 currently. We hopefully won’t ever confront another GFC ever but arguably the economy is slowing as exhibited by numerous metrics including the annualized six-month rate of US Leading Economic Indicators “(LEI”). A Senior Director of Economics at The Conference Board which publishes the LEI noted with the release of December LEI which declined sharply again, “There was widespread weakness among leading indicators in December, indicating deteriorating conditions for labor markets, manufacturing, housing construction, and financial markets in the months ahead.” According to The Conference Board, “The trajectory of the U.S. LEI continues to signal recession.” The trajectory, down ~8.5%, is a much steeper rate of decline than the annualized previous six-month period, at ~4%. Since 1999, we have not witnessed the current negative trajectory of U.S. LEI except of course during the pandemic, the GFC, and 2001. A critical and relevant difference from those past situations was the FED was then actively focused on improving liquidity and lowering rates in a concerted effort to improve LEI versus the current situation when the FED’s primary focus is fighting inflation by raising rates coupled with QT to slow the economy, and with their particular focus now being wage inflation.
Staffing services are cyclical. As noted by the American Staffing Association, the staffing and recruiting industry is “hyper cyclical.” Robert Half has greatly benefitted from cyclical tailwinds but tailwinds are increasingly becoming headwinds. In addition to cyclical tailwinds driven by both monetary and fiscal stimulus, RHI has benefitted from some non-recurring COVID-driven fiscal benefits which enabled the Company to over-earn in its Protiviti business segment as well as non-recurring volume across the administrative/support vertical within talent solutions. Management does not expect that growth headwind to completely abate until the second half of this year.
Although RHI has declined by ~35% since its February 2022 peak, the stock remains vulnerable to more downside and especially under a recessionary scenario which is undoubtedly not a desired outcome by FED officials but one that they are willing to accept, as is consistently communicated, to achieve their inflation mandate. The likelihood of a recession scenario is clearly well-documented as reinforced by “recession” being among the top five most searched “definitions” across Google last year and searches for “recession” being up over 350% at the end of September. Having recently returned from multiple meetings at the ICR investment conference, it has become sort of a joke among some management teams that this is the most “well-telegraphed” expected recession. The National Association for Business Economics (“NABE”) recently noted that employment growth during the past three months was the lowest reading by NABE since April 2021. NABE’s President said, “For the first time since 2020, more respondents expect falling rather than increased employment at their firms in the next three months.” In addition, 64% of survey respondents said they feel the U.S. is either already in a recession or has a more-than-even likelihood of entering a recession in the next six months.
Regardless of whether we officially have a near-term recession though, it is clear from RHI’s recent Q3 results coupled with a variety of temporary staffing metrics that employment trends will moderate at-best. At the beginning of 2022, the sell-side was not forecasting 2022 as being “peak EPS.” For example, Barclays’ analyst who has been covering the staffing industry for over 14 years was envisioning EPS for 2023 at $6.83 as described in his research report at the end of April. He has adjusted his estimate substantially since then and consensus, now $5.29 for 2023, is 22.5% lower than his April estimate. I am not trying to offend anyone at Barclays or across the sell-side as there is little visibility at Robert Half as described by management’s own admission but as of now, consensus EPS for 2023 is envisioned to be 12.1% lower than 2022 based on consensus revenue that is 5.3% lower. Consensus EPS for 2024 is currently for a quick recovery from the expected decline in 2023. I envision that consensus for 2023 will be lower by the end of this year than now and market participants will also adjust their expectations downward for 2024 as well.
The Company has a strong balance sheet and has capitalized upon favorable cyclical dynamics but as unfavorable dynamics drive a less favorable employment environment, I envision further vulnerability to RHI’s equity as business deteriorates relative to current consensus estimates that are reset lower. Based on evidence of weakening employment trends and the FED’s outlook for 4.6% unemployment this year, I envision that Robert Half’s peak-to-trough EPS will be worse than 12%. I envision that RHI’s stock will decline as more clarity pertaining to weakening employment trends materialize or is forecasted by RHI’s management to influence analysts and market participants accordingly to reset their expectations lower for 2023 and 2024. At a target of 20% downside, that would be roughly equivalent to the low RHI’s stock made on October 21st pursuant to the Company’s announcement of weaker-than-expected Q3 results and an outlook for Q4 that was worse-than-expected. My 20% downside scenario values RHI at ~10x “peak EPS” generated in 2022. RHI’s equity is likely more vulnerable if a deep and protracted recession develops.
Predictions of a recession in 2023 have grown as the Federal Reserve continues to hike interest rates in its effort to address a historically high inflationary environment. The FED has hiked further and faster than anytime in modern history. Whether you agree with them or not, the FED has made it clear that their fight against inflation is not over. The market has become optimistic that inflation is cooling. If the FED is really data-dependent and “inflation is cooling,” then the FED might become less hawkish but then the big question is whether the rate hikes already have triggered conditions for a recession.
FED speakers are relatively consistent that they are determined not to back off too quickly which in other words will likely mean to “pause” but not “pivot” once the FED accepts a moderating trend of inflation that it deems is consistent with achieving its mandate. If they were to “pivot,” the catalyst for such is most likely a dire economic situation which would manifest more downside to RHI in advance of that “pivot.”
A favorable employment backdrop is reversing since the FED is focused on unwinding the labor imbalance as part of its “war against inflation.” A reduction to the labor imbalance will likely require a substantial increase to the unemployment rate. As FED Chairman Powell highlighted during his Brookings speech, half of core PCE is comprised of services ex-housing. Service inflation is very closely tied to the labor market. Labor supply remains below pre-COVID levels despite population growth. FED Chair Jerome Powell acknowledged the issue during December when he told an audience that the central bank has to assume that restoring balance in the labor market will come almost entirely from moderation to the demand side instead of from an improvement in labor supply.
Although some might assert otherwise, the FED is aiming for a recessionary labor market. The FED is projecting that the unemployment rate will increase from a low of 3.5% in December by at least 100 bps to 4.6% under “appropriate monetary policy.” For some historical context, it’s relevant to note that the unemployment rate has increased by 1% within a year twelve times since WWII and each time the economy experienced a recession. Furthermore, the unemployment rate continued to increase far beyond the initial 1%. The cumulative increase to the unemployment rate has ranged from 1.6%-11.2%; the median increase during the twelve times is 3.5% of a cumulative increase. The FED’s December projections were for a median unemployment rate of 4.6% in 2023, 4.6% in 2024, and 4.5% in 2025. Might it be “different” this time? Only time will tell if unemployment will indeed rise towards the FED’s current projection, which incidentally was 20 basis points higher in December than their projection in September, but history demonstrates that the trend in the unemployment rate has a substantial amount of inertia once it begins to rise.
Temporary staffing performance generally leads the broader labor market by 2-4 quarters. The primary reason that companies use staffing firms is flexibility. “Temporary labor in a recession can be described as FIFO. Flexible labor is first out the door at the beginning of an economic downturn and the first ones back in when recovery starts.” The staffing and recruiting industry is “hyper cyclical”—its business cycle tends to be exaggerated during economic expansions and contractions. The U.S. Bureau of Labor wrote during 2021, “The idea that temps have enhanced labor flexibility for firms was most evident during the most recent recessions (1990-91, 2001, and 2007-09) and subsequent recoveries. During the Great Recession, for example, temps experienced a larger share of the job losses—34% decline for temps compared with 8% decline for all private employment—and during the recovery, a larger share of the job gains—75% growth for temps, 19% growth for all private jobs.” The market is primarily focused on the headline employment data despite it being a lagging indicator but is missing the recent degradation of the temp staffing metrics which generally leads the broader labor market. The degradation of the temp staffing metrics was evidenced from RHI’s Q3 results and management’s commentary and such is reinforced from data collected by the Bureau of Labor.
Temporary help services employment has declined during the past five months through December. In fact, temp penetration declined to 1.98%, its lowest in more than a year. Temp job growth declined by 1.1% year-over-year from up 1.4% in the prior month. Moreover, for the first time in seventeen months, temp wage growth decelerated on a year-over-year basis during December. If this were to persist, it implies headwinds for temp staffing gross margins. There is increasing evidence of hiring freezes and corporate downsizing. Based on primary research, I envision that temp labor will ease and such degradation will be compounded by temp wage growth trending lower. This does not portend towards strong positive bill-pay spreads in the near term.
RHI’s stock prices does not adequately discount issues associated with the compounding adverse impact that will likely materialize as demand for both the Company’s temporary and permanent staffing services deteriorate as is the “desired outcome induced by the FED.” Although I am not asserting that RHI will confront an environment as difficult as the GFC, it’s worth noting for historical context that the Company’s revenue peaked in 2007 and did not return to that level until 2014. Also relevant is that RHI’s operating margin peaked in 2006 at 11.2% and did not return to that level until 2015. During 2009, the Company’s operating margin, at just 2.2%, had deteriorated by 1000 basis points from 2006. During the period 2006-2008, margin averaged 10.2%; during the period 2009-2011, margin averaged 4.1%. Margin for 2022 is estimated at 12.2% after generating 12.5% in 2021. RHI generated a 10.2% margin during each of the two years that preceded the pandemic in 2020. The Company’s margin these past two years at 200 bps or higher reflects some mix and operating leverage benefits which I do not expect to recur in the near-term. Higher-margin mix benefits accrued from business at both Protiviti and permanent placement and the magnitude of such higher-margin business is at-risk. Operating leverage of course works both ways and although management has historically exercised cost discipline to adjust to cyclical-driven challenges, they have yet to modify their headcount strategy to avoid a “self-fulfilled prophecy.” Their strategic decision is in spite of management highlighting weakening staffing-related trends at the Company and demonstrated more broadly within the BLS data.
The SMB market is RHI’s core clientele as demonstrated by ~80% of the Company’s staffing revenue earned from clients with 50-100 employees. One can review data and discuss trends and expectations with the NFIB (National Federation of Independent Business) as part of their research process pertaining to Robert Half. During March 2009, the data from NFIB demonstrated the weakest outlook since 1974-75 and 1980-82 recessions. That is hardly the case now as demonstrated by the recently-titled NFIB report, “Small business labor shortages continue even with gloomy outlook.” The recent NFIB report highlights “the labor market continues to be a big challenge for small business owners…however, the trend in planned hiring is clearly on the decline, now below most of the 2016-2019 strong expansion numbers.”
Robert Half is a strong company as evidenced by its ten-year average ROIC that exceeds 30% which included only one year slightly below 25%. However, the Company is not immune to an economic slowdown. As described by the Company in its risk factors, any decline in the economic condition or employment levels of the U.S. or any of the foreign countries in which the Company does business may severely reduce the demand for the Company’s services and thereby significantly decrease the Company’s revenues and profits. The staffing industry has greatly benefitted from a variety of tailwinds that has led to the lowest jobless rate in fifty years and RHI has capitalized on the industry’s strength as evidenced by over 26% EPS CAGR since the trough in 2009. The magnitude of demand degradation to RHI’s staffing services will not likely be as bad as during the GFC when revenue declined by 35% from peak-to-trough from 2007 to 2009 and EPS was decimated by over 85%. That said, when reviewing past economic slowdowns, it’s unlikely that 2023 EPS will be down only 12% with a rebound in 2024 EPS if employment trends turn less favorable which is already being evidenced and is the “desired outcome” by the FED.
At the Company-specific level, Robert Half generated a substantial magnitude of higher-margin business from its Protiviti business segment. Protiviti is a global consulting firm delivering services that include internal audit, technology consulting, risk and compliance consulting, and business performance improvement. Clients range from high-growth, pre-public/transactional established start-ups to the largest global companies and government entities. The Company derived much benefit at Protiviti from public sector spending to address COVID relief efforts but such spending has largely been eliminated and therefore RHI is confronting significant deceleration from the public sector. The pandemic-driven surge in business was derived from services delivered to the public sector to address the volume of claims for both unemployment and housing assistance, as well as the demands that challenged public school districts in regards to technical support requirements of virtual learning models. During Q3, public sector Protiviti revenue declined 43%, a further degradation from the 30% decline in Q2. Management stated that the public sector runoff of federal spending on unemployment claims processing and a large financial services project wind-down will have a double-digits impact in Q4, then narrow to mid-single digits during the first half of 2023 and fully lap during the second half.
Within talent solutions, the Company’s temp staffing for administrative and customer support fell 10% during Q3 despite easier year-ago comps. This was also ascribed to the wind-down of public sector unemployment claims processing as well as fewer large projects linked to open enrollment. Permanent placement is a higher margin business for Robert Half and a sharp decline to this business mix will have a disproportionately large impact on RHI’s EPS. During the past twenty years, permanent placement generated a negative segment margin in 2002 and 2009. This is a component of the business that might incur a meaningful near-term drawdown given that Robert Half management continues to ramp-up the number of recruiters for this business segment despite the magnitude of announced hiring freezes and layoffs. Primary research within the permanent staffing sector suggests that this higher-margin business mix might confront “severe headwinds” as recent tailwinds from elevated employee churn subsides. Primary research highlighted that strength in permanent placement was abnormally high since much of it “reflected pent-up attrition from the pandemic when mobility was limited.” The Company’s permanent placement revenue was almost 40% higher during the YTD through Q3 of 2022 versus the same period during 2019. RHI’s permanent placement margin for 2022 was approximately 200 basis points higher versus 2019.
Robert Half will report this week. The stock price is roughly equivalent to where it traded on October 20, 2022 when RHI posted its third quarter results that clearly disappointed the market then as evidenced by RHI’s stock price declining by as much as 18% the day post-earnings. Q3 results were weak across-the-board in revenue, margin and EPS relative to consensus. Underperformance was notable in administrative & customer support temp staffing and Protiviti. Management highlighted a slowdown in the pace of client hiring, longer sales cycles, and weakness among its core SMB clientele. RHI’s guidance for Q4, at 2% top-line decline (mid-point), was well-below consensus of 6.2% growth. Margin degradation was worse than anticipated and partially ascribed to higher fringe benefits and increased SG&A. In regards to SG&A, though management stated its intent to be mindful of macro headwinds that might require adjustments to its cost structure, it also noted that it does not plan to make major reductions in headcount ahead of market conditions for fear of creating a self-fulfilling prophecy. Management’s headcount strategy could pose further risk to operating margin if the unfavorable employment cycle is worse than management is currently anticipating.
In spite of the Company’s poor Q3 results and lower Q4 guidance, the low printed on October 21st has thus far proven to be a “smart buy” since RHI’s stock has not fallen below that ~$65 low. In fact, RHI has appreciated by ~20% from its low on October 21st. One can argue that other cyclicals have also significantly outperformed the market and indeed that is true but I am confident that employment trends have peaked for this business cycle and RHI’s stock does not adequately discount that scenario.
Although my short recommendation is not based on this week’s earnings call, I wanted to post the idea in advance to provide VIC members with some background for being short now although obviously Q4 results and the call might provide a better entry point. Given the severity of the Q3 shortfall and relatively negative sell-side sentiment, there is a plausible case that Q4 expectations have been adequately reduced (i.e., “de-risked”) going into the print. Relative to the consensus estimates for Q4 that preceded the day before the Company announced its Q3 shortfall and provided its Q4 outlook, consensus for Q4 revenue is 7.5% lower and for Q4 EPS is over 11.5% lower. Since RHI’s stock price is roughly flat from the close that preceded the Q3 shortfall and reduced Q4 outlook, one can argue it was already discounted. There’s a tug-of-war being manifested in the markets focused on whether/when and to what magnitude there will be a recession. That will always remain an interesting topic of debate but I am convinced that the favorable employment trends have peaked for this business cycle and although some of that is already discounted in RHI’s price that peaked at ~$125 during February 2022, the risk/reward for being short now remains attractive.
Management candidly admits to having little visibility in its business. This is demonstrated recently during the Q3 earnings call in response to a question asked by the Barclays analyst. CEO Keith Waddell said, “Well, as to visibility, the nature of our business is we don’t have a lot of visibility…And so we’ve never had visibility to any great extent, and we still don’t have visibility.” The nature of RHI’s business is largely cyclical and those cyclical trends of favorable employment have been very strong as evidenced by an unemployment rate at a 50-year low. Management rarely has much visibility because the staffing services business is highly cyclical and highly competitive, the barriers to entry are quite low, and long-term contracts comprise a negligible portion of RHI’s revenue.
The Company has done a great job at capitalizing upon the favorable employment trends but as with any cyclical, the favorable tailwinds are becoming tailwinds. That might not drive a miss yet to Q4 results this week, especially as those were recently “de-risked,” and the market might already be sanguine with the magnitude of the reduced revenue, down 5.3%, and EPS, down 12.1%, as implied by consensus estimates for 2023 versus 2022. That is of course among the risks to this short thesis—that the market has indeed discounted the expectation for cyclical headwinds and is already looking through such to anticipate the rebound from ~13x “peak” 2022E EPS.
When RHI bottomed in March 2009, it traded at 7.6x the prior peak annual EPS of $1.85 reported in 2007. During the 1990-1991 recession, RHI troughed at ~8x peak EPS; during the 2001-2002 recession, RHI troughed at ~12.5x peak EPS. It’s worth reinforcing that the FED is consistent in its message that there won’t be a “pivot” very soon and this is quite different than the FED’s action during 2001-2002. After the FED raised its rate by 175 basis points during 1999-2000 to a 6.5% level on May 16, 2000, it reversed course during 2001 by 475 basis points to a 1.75% level on December 11, 2001. We can look back to the GFC and witness the FED having taking the rate to 5.25% on June 29, 2006 and reverse its course starting in September 2007 that ultimately led to 0-0.25% on December 16, 2008. RHI’s stock troughed soon during March 2009 after declining ~30% pursuant my December 2008 posting but the FED was then at 0-0.25% versus 4.25-4.50% now and going up to at least 4.50-4.75% on February 1st. Although I hope for the sake of our economy that RHI’s peak-to-trough decline to revenue and EPS does not mirror the 35% and 86% decline, respectively, that materialized during the GFC, I am confident that RHI will get worse than being down from peak 2022 of just 5.3% in revenue and 12% in EPS as envisioned by consensus for 2023. Goldman Sachs Research which remains negative on the equity envisions 2024 revenue and EPS being higher. History dictates otherwise absent “this time being different.”
Management lacks “visibility” to its business but employment trends are clearly influenced by the strength of the economy and the FED wants the economy to slow-down and anticipates unemployment rising to 4.6% this year. There’s strong historical evidence that once the unemployment rate rises by at least 100 basis points, it goes higher. I think those willing to own/invest in RHI now at 13x “peak” EPS will witness lower levels to accumulate more of RHI for the next cycle of improving employment trends which won’t likely materialize anytime soon absent the “pivot” by the FED but that “pivot” will be driven by a prioritization of their employment mandate versus the current prioritization of their inflation mandate. When they do “pivot,” the employment situation will likely be at a “pain threshold” such that RHI’s EPS will worsen considerably and political circumstances will pressure FED action. There are multiple scenarios to consider for when to cover Robert Half and these scenarios largely depend on the severity of unemployment which is partially being driven as the desired FED outcome. For my own investment purposes, in thinking through historical patterns, I currently am inclined to cover part of my short at 10x “peak” EPS, or ~$60.
While there are some structural arguments for a lower unemployment rate, the fact is employment trends are reversing and this is a desired outcome by the FED which is targeting lower inflation with a focus to do so partially by its expectation for higher unemployment. This is a stark reality for all staffing service companies and especially Robert Half which derives over 70% of its contract talent solutions from the finance/accounting verticals which in addition to cyclical headwinds confronts secular challenges as well. During October 2020, Martin92 did a great job at framing some of the competitive secular issues in his VIC posting of RHI as a short so I won’t repeat those here.
Selected Risk Considerations
Selected Catalysts
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