Description

"Employers in U.S. Cut 533,00 Jobs, Most In 34 Years, As Recession Deepens"

 

Although Robert Half International (RHI) is a well-run company, the current economy confronts the Company with numerous challenges that are not adequately discounted by its stock price. RHI’s stock fails to reflect issues associated with the compounding adverse impact of decelerating professional staffing services demand coupled with negative operating leverage. In applying a historical perspective, based on recent past recessions which were neither as deep nor prolonged as I anticipate the current to be, I derive a target cover price of $14 for RHI (i.e., 30% below where RHI closed on Friday). Note that $14 target for RHI implies 20x the current consensus ‘09E EPS which incidentally I expect to be further reduced (among the catalysts); the $14 target represents 7.5x peak EPS which was achieved during this business cycle as of Q2’08. In consideration of the short thesis and of potentially being wrong regarding the envisioned decline in RHI’s stock price to $14, I find it highly likely that RHI will at the very least provide an attractive source of alpha (i.e., many attractive longs exist that would rise by more than RHI if it doesn’t decline to $14 or even it continues to rise). Fundamentals for employment staffing service companies won’t be strong for awhile and do not support a higher price for RHI shares.  

Robert Half International is the largest U.S. provider of temporary personnel in the fields of finance and accounting. In 2007, the Company generated ~80% of its business from these fields. RHI provides staffing and risk consulting services in North America, South America, Europe, Asia, and Australia. It operates through three segments: Temporary and Consultant Staffing (79% of Revenue in Q3’08), Permanent Placement Staffing (9%), and Risk Consulting and Internal Audit Services (12%). The Temporary and Consultant Staffing segment provides specialized staffing in the accounting and finance, administrative and office, information technology, legal, advertising, marketing, and Web design fields, as well as places project consultants in various positions, such as creative directors, graphics designers, Web content developers, Web designers, media buyers, and public relations specialists. The Permanent Placement Staffing segment provides full-time personnel in the accounting and finance fields, including chief financial officers, controllers, and senior financial analysts; administrative and office fields; and information technology fields, such as specialists in programming, networking, systems integration, database design, and help desk support, as well as chief financial officers, controllers, and senior financial analysts. The Risk Consulting and Internal Audit Services segment provides business and technology risk consulting and internal audit services.

I am among the VIC members voting that there are numerous bargains in this market but RHI is certainly not among them when trading at 29x ‘09E EPS (a consensus forecast I expect will be reduced), a 75% premium versus the peer average and 102% premium versus the median average. I agree that RHI is a better business model than the peer average but this premium is not justified. I also recognize that RHI’s business is cyclical and therefore one should expect higher P/Es at the bottom (and among some staffing service companies, valuation thinking will probably be accorded to negative earnings). Nevertheless, across other valuation parameters, RHI is still too expensive and especially based on my assertion that revenue and earnings will continue to decline. On a LTM Revenue basis, the premium to the peer average is 92% and to the peer median it is 111%. On a LTM EBITDA basis, the premium to the peer average is 31% and to the peer median it is 35%. As described more later, it is worth noting that during the 1990-91 recession the trough valuation for RHI was 0.4x Peak Revenue and 8x Peak Earnings. Applying these multiples to RHI’s peak during this business cycle implies a $15 stock.

Although the most recent labor report (released 12/5/08), at 533,000 nonfarm payroll job losses, was much worse-than-expected (versus 325,000 forecasted consensus decline), the stock of global staffing service firm Robert Half (RHI) ended the day up 6.1% (versus the S&P 500 up 3.7%) and moved up 11% from its low on the day (versus the S&P 500 up 7% from its low on the day). 

I suspect there was both buying from existing and incremental longs coupled with short covering based on those rationalizing to buy (or cover) “the news” (i.e., the thinking that the horrible nonfarm payroll figure is a lagging indicator that will soon improve). I assert the importance of history to evaluate the cyclical staffing service industry and highlight that during the last two recessions, RHI’s business witnessed falling revenue growth for 2-3 years before a rebound occurred. Framed by a six-month time horizon, I believe RHI is an attractive short for numerous reasons as described below. To begin with, on a thematic/macro basis:

1.      I believe the unemployment report from Friday, despite it being a lagging indicator, will likely get worse in the coming months

·        Until September 2008, the loss in payroll employment was running at less than half the percentage rate of loss in the previous two recessions (in 1991 and 2001); however, job losses over the past three months have changed that

·        The Bureau of Labor Statistics reported Friday that nonfarm payroll jobs fell by 533,000 in November; with downward revisions to the prior two months’ figures as well (September revised to loss of 403,000 from 284,000; October revised to loss of 320,000 from loss of 240,000)

·        I believe that this recession will be deeper and longer than the previous two and I think part of this is validated by the payroll losses announced on Friday already being the biggest loss number among the past business cycles since 1974; largest monthly job losses (per U.S. Department of Labor Bureau of Labor Statistics) in prior cycles follows

Ø      533,000 in November 2008

Ø      325,000 in October 2001

Ø      306,000 in February 1991

Ø      431,000 in May 1982

Ø      602,000 in December 1974

·        It’s worth noting that over the eleven months since the 2008 recession “officially” began (i.e., as of December 2007 per the National Bureau of Economic Research), payroll figures have yet to decline as much as the prior two recessions

·        For example, eleven months after the start of the 2001 recession (three months after it officially ended), payroll employment had fallen 1.6%; this compares with just the 1.4% decline since the 2008 recession officially began and I assert that this recession will indeed be deeper and longer than in 2001

·        It’s worth noting as important context regarding the 2001 recession, that RHI announced its fourth consecutive quarterly miss and its third quarterly preannouncement during Q1’02

·        Furthermore, revenue declined 34% from the peak quarter to trough quarter and this took five quarters to occur while EBIT margin declined from over 10% to negative 2.5% over a seven quarter period

2.      I believe unemployment issues in Europe (where RHI sources ~20% of its business) will also continue to be grim

3.      Weakness in the overall labor environment and negative signals in the temporary labor market is correlated to difficult times ahead for staffing companies

• Temporary employment in November was down 15.7%, a worse rate than October’s 12.7% decline and September’s 10% decline
• Unadjusted temporary staffing, typically a leading indicator for overall employment, has been declining year-over-year for twenty consecutive months, and the rate of decline is still worsening
• The temporary penetration rate has declined from 1.66% to 1.60%; this is historically a negative signal and is at the lowest rate since December 1996
• Weakest NFIB small-business employment outlook since 1974-75 and 1980-82 recessions pose negative implications for SMB target which is RHI’s core clientele
• Earnings did not bottom for most staffing service companies until late 2002 or 2003 following the recession in 2001
• Some historical context follows from 1990-91 and 2001 recessions

1990    1991    1992                2000    2001    2002

Ø      Non-farm Payroll Growth         1.4%    (1.0%)0.3%                2.2%    0.0%    (1.1%)

Ø      Temp Help Empl Growth          ---        (2.8%)7.8%                6.8%    (11.3%) (6.2%)

Ø      RHI Revenue yoy Growth         6%       (16%) 5%                   30%     (9%)    (22%)

Ø      RHI Operating Profit Margin     12.9% 9.5%    7.0%                10.8% 7.7%    (0.1%)

Moving to some RHI-specific issues

4.      Q3’08 results (released 10/22/08) evidence just the beginning of negative trends that will persist for several quarters

• Sequentially, Q3 revenue growth fell sharply with temporary moving from +6% to -1% and permanent moving from +11% to -4%
• Moreover, on the Q3 call, management described how conditions deteriorated throughout Q3’08 and that early October experienced sharper erosion
• Specifically, during the first three weeks of October, temporary was down 9% and permanent fell 26%
• Management accordingly reduced Q4’08 guidance to $0.25-0.30; this was substantially below the Q4’08 consensus of $0.40 (at the time)
• On this news, RHI’s stock declined by 15.7% over the next three days (almost twice the 8.2% decline in the S&P 500)

5.      Highly exposed to a negative leverage effect (especially permanent placement)

·        Negative leverage most recently evidenced during Q3’08 earnings call: midpoint of guided Q4 revenue was 10% below prior Street mean revenue forecast but midpoint of EPS guidance was 31% below the prior mean estimate

·        Although management continues to work aggressively to right-size SG&A costs for expected lower revenue levels, cost cutting will not likely be enough to offset accelerating year-over-year revenue declines

·        From a historical perspective, operating margin peaked at 12.9% in 1990 and at 10.8% in 2000 prior to the last two recessions; margin declined from peak-to-trough in 1990 until 1993 by 740bps to 5.5% and from peak-to-trough in 2000 until 2002 by 1090bps to negative 0.1% (it wasn’t until 2005 when margin grew to 11.5% to finally exceed the prior peak)

·        RHI’s LTM operating margin at 9.86% is 58% more than the peer average and 72% more than the peer median; part of the better margin is associated with a better business model and better management but a large part is also attributed to ~10% mix of the substantially higher margin permanent segment which is most at risk in this environment and incidentally larger mix to RHI than in the prior 2001 recession

·        Permanent placement (at ~20% of total operating profit) is concentrated in accounting/finance and has disproportionate impact on profitability

·        Serving as additional evidence of the negative leverage effect, and as described earlier, during the more moderate 2001 slowdown cycle, revenue declined 34% from the peak quarter to the trough quarter but EBIT margin declined from over 10% to negative 2.5%

6.      RHI’s non-U.S. mix is further compounded by the recent rebound in the U.S. dollar

• Recent strength of the U.S. dollar will likely exacerbate the slowing international growth, changing from a substantial tailwind into a headwind next quarter
• Note that over the prior four quarters through Q2’08, F/X translation benefitted RHI’s revenue growth by almost 2.5% per quarter
• If exchange rates stabilize at current levels, F/X will become a 1-2% year-over-year headwind during the first half of 2009 which will compound slower growth from Europe and aversely impact profitability
• Note that the U.S. business began to decline year-over-year in Q2’08 while overall growth remained positive because of strong performance by its international segment but this was aided by U.S. Dollar weakness which has now reversed
• During Q2’08, U.S. declined by 1% and international grew by 32% but currency benefit was 10% (i.e., international growth was 23% on constant currency growth basis and since we know our economies are not de-coupled and especially between the U.S. and Europe, we can be certain that international growth will not be the contributor it was earlier in the year)

7.      Using history as a guide (i.e., embracing some pattern recognition), earnings estimates are still too high and will be missed and/or lowered; this is a key catalyst towards the stock ultimately discounting near-term issues more appropriately

• Subsequent to management reducing guidance for Q4’08, the consensus estimate was substantially reduced within management’s range of guidance (now at $0.27)
• However, Q1’09 consensus estimate is $0.18 and ‘09E EPS is $0.69 but there is a wide dispersion among the estimates (for Q1’09, the range is $0.08-0.27; for ’09, the range is $0.36-1.20) and I expect estimates to continue to be reduce (given last week’s visibly poor nonfarm payroll figure, I would be surprised if some analysts didn’t reduce their expectations for 2009 starting this week)

8.      During the last two recessions, RHI’s business faced falling revenue growth for 2-3 years before a strong rebound occurred

·        In the eight quarters from peak revenue in Q4’00, temp staffing revenue fell 35% from the peak quarter and permanent placement declined 66%

·        Given that revenue peaked in Q2’08 this cycle, history suggests that revenue and earnings shortfalls are likely for several quarters

·        A key difference between the last business cycle and current cycle is that international is now 30% of business mix (versus 15% previously); the international mix coupled with the weak dollar earlier this year was among the key areas of strength at RHI and will now be a major caboose (especially given the stronger dollar and an international cost structure that is less flexible)

9.      RHI currently trades at a substantial premium to the peer group on P/E, Revenue, and EBITDA basis

(peer group defined by MAN, CDI, ASGN, KELYA, TBI, RECN, MPS, KFY, HSII, KFRC)

• On ‘09E earnings basis, RHI is currently trading at 29x EPS (based on $20 stock price and consensus EPS of $0.69 which I have asserted will decline); this is a 75% premium versus average peer ‘09E P/E (at 16.6x) and 102% premium versus median peer ‘09E P/E (at 14.4x)
• On LTM Revenue basis, RHI is currently trading at 0.56x Revenue; this is a 92% premium versus average peer LTM Revenue multiple (at 0.29x) and 111% premium versus median peer LTM Revenue multiple (at 0.27x)
• On LTM EBITDA basis, RHI is currently trading at 5.0x; this is a 31% premium versus average peer LTM EBITDA multiple (3.8x) and 35% premium versus median peer LTM EBITDA multiple (3.7x)
• Relative to what many would characterize as RHI’s closest peer—specifically Manpower (MAN)—RHI is trading at 193% premium to MAN’s 10x ‘09E EPS, 367% premium to MAN’s 0.12x LTM Revenue, and 56% premium to MAN’s 3.2x LTM EBTIDA

10. Reinforcing my near-term bearish perspective are RHI insiders who have been substantial sellers of their stock; although this is perhaps just coincidental, I ascribe some weight to it given that we are witnessing a recent high among company insiders elsewhere as evidenced by substantial insider buying among a vast number of company insiders

• Director Edward Gibbons has sold 38% of his shares since the end of October (Gibbons has sold 53% since the beginning of 2007)
• Director Frederick Furth has sold over 90% of his shares since the beginning of November 2007
• EVP Robert Glass has sold 24% of his shares since the beginning of November 2007

Current Valuation Summary and Framing of Target Price

Current equity valuation:            $3.1B (12x ‘08E and 29x ‘09E EPS)

(peer median at 14x ‘09E EPS)

Current enterprise valuation:      $2.7B (0.56x LTM Revenue, 5x LTM EBITDA)

(peer median at 0.27x Revenue and 3.7x EBITDA)

Framing a Target Price of $14

In framing a target price, I am not going to detail my own earnings estimate (however, I will of course respond accordingly to any requests for such) since there are seventeen analysts preparing such earnings models and I think the exercise yields a false sense of security given the spurious accuracy of such and as evidenced by the acceleration of estimate reductions during past recessions. The analysts will ultimately get there, thereby partially providing the catalyst, and I am applying history as a guide to embrace a continued decline in RHI’s results because of exogenous events that management can neither influence nor buffer enough by increasing their own cost discipline. I think the current price for RHI is mis-guided towards the belief that employment will rebound by the middle of 2009, that RHI management can reduce the cost structure accordingly, and/or that RHI deserves the enormous premium currently being accorded to it. Moving on to some points that frame my $14 target (which incidentally assumes a deeper/prolonged recession than the most recent experiences but not the devastating impact of 1930-like issues that I think government will ultimately effectively address):

• Even though I expect the current ‘09E consensus to decline from $0.69, in using this estimate, I deem 29x and the described premium to the peer group as unsustainable; there are ways to rationalize 20x earnings because of the cyclical nature of the business model and such would imply $14 for RHI shares
• During the 1990-91 recession (I don’t use 2001 given it was not as broad-based since driven by tech bust), trough valuation was 0.4x Peak Revenue and 8x Peak Net Income

Ø      In applying these measures to this cycle’s peak for RHI (i.e., as of Q2’08), this would imply a price of $15 for RHI’s shares

• Dividend yield of $0.44 won’t be reduced and ultimately would provide attractive coupon for waiting as economy weathers employment storm but gets closer to recovery for which RHI is then levered for upside

Ø      In applying implied yield of 3% to $0.44 cash dividend, this would imply a price of $14.67

Ø      In applying implied yield of 4% to $0.44 cash dividend, this would imply a price of $11.00

• Subsequent to the last recession, RHI shares bottomed at $12.50 in 2003

Ø      If a comparable decline in the peak-to-trough price were to materialize in today’s business cycle, this would imply a price of ~$14 for RHI’s shares

Selected Arguments against the Short Thesis

• Unlike the substantial issues associated with equities having net debt positions (which have suffered substantial declines regardless of debt maturity schedules), RHI maintains a strong balance sheet, at $2.39 net cash per share, and pays a dividend
• Strong operating leverage to eventual economic recovery (but note that I advocate the RHI short thesis as described above as an investment that should work over the next six months as catalysts materialize and/or the stock converges to a more reasonable valuation that discounts the severity of near-term issues)
• Sentiment among sell-side analysts is already negative
• Company has been a recurring buyer of its shares; although I deem Company insider activity as more meaningful, the fact that RHI has an authorization for ~14 million shares is a source of incremental buying

Ø      In 2006, RHI paid ~$35 and spent $274M to buyback its shares

Ø      In 2007, RHI paid ~$33 and spent $397M to buyback its shares

Ø      In 2008 YTD (through Q3) paid ~$25 and spent $131M to buyback its shares

 

 

Catalyst

Selected Catalysts

Weakness in the overall labor environment and negative signals in the temporary labor market is correlated to difficult times ahead for staffing companies
U.S. and European employment and economic growth tempers demand for the Company’s core staffing services; this should drive substantial deleveraging of RHI’s fixed costs, and accelerating year-over-year earnings declines throughout 2009
Earnings misses and/or reductions
Negative operating leverage is just starting to manifest itself
Most significant cyclical risk in permanent placement business (approximately 20% of Company profits)
Magnitude of premium valuation versus peer group isn’t justified and some multiple compression materializes based on increasing concern regarding near-term earnings
Timing for Protiviti business to recover since SEC might not require adoption of IFRS (standardization of international accounting) until 2014
Relative strength of dollar