Description

I’m short Robert Half (RHI) - a temp staffing business that faces a number of long-term headwinds, including new competition, and is likely to recover from the current downdraft more slowly than bulls anticipate. I get to value of $40-$45 (or 10-11x prior peak EPS) vs. a stock price today of $56. 

While RHI reports earnings tonight, this is not a call on the quarter. If anything, I meant to post this sooner and the earnings release acted as a friendly nudge to finally put pen to paper.

Robert Half is largely a temp staffing business. It has ~3% share of the overall market but a bigger chunk US accounting and finance temps at ~20%. RHI also does permanent placements and has a risk consulting arm called Protiviti that specializes in internal audit. The latter was acquired from Arthur Anderson post-Enron. 

The key with RHI is that the majority of EBIT (close to 70%) stems from temps. And of that figure, about 70% comes from functions that are accounting and finance related. This would be grouped under what RHI calls “Account Temps” (accounting, finance and bookkeeping) and “Office Temps” (admin personnel and office clerks). As I’ll come back to later, these are areas that are in clear decline and face increasing competition.

As a result, it shouldn’t be surprising that RHI hasn’t grown much cycle-to-cycle. For example, temps placed in FY19 were 202k compared to a peak of 257k in FY07. Furthermore, if you look at EBIT in the two core segments (temp and permanent placement), it’s roughly flat from FY07 through FY19 (up only 8% in total). To their credit, they’ve done a better job growing their Protiviti segment (called “Risk Consulting and Internal Audit”) but this was off a smaller base and it’s the segment that probably faces some of the bigger challenges in a prolonged malaise. 

The point of this is to say that RHI is a mediocre business - it’s low margin, low growth and hasn’t really expanded cycle-to-cycle. So why is this? The answer is that it faces a number of structural headwinds. Chief among these is the fact that the job functions it serves are in secular decline. If you look at the employment statistics for RHI’s bread & butter areas (data entry, bookkeeping, office clerks), you’ll see these have been declining at a MSD rate and this has been ongoing for a number of years. Among other things, this is due to increased productivity, automation and new software offerings, which I’ll come back to later.

As you would expect, RHI is a hyper cyclical business. In the last recession, EBIT declined 86% and you’ll find similarly nasty drops if you go back further to prior recessions. Temp demand has historically been inversely correlated to unemployment. So while the headline job loss numbers have come down, an elevated level of unemployment will present a challenging backdrop for RHI nonetheless.

Indeed, the recent trends have not been good. EBIT in Q2’20 declined 64% and trends into summer remained depressed - both temp and permanent placement were running down in the mid 30%s into July, little improvement from what was seen in Q2. I’m sure that RHI will report an improvement in Q3 and I trust things that things have gotten better. However, Street currently projects EBIT in FY21 of $450m, down ~25% from peak FY19 levels. This would be a quick snap back for a business like Robert Half. Again, prior recessions have seen out year EBIT declines well over 50% from prior peak with unemployment in the HSD range. 

Furthermore, I think there’s reason to believe that this cycle could pose some unique risks for RHI, potentially making it more challenging to recover as quickly as bulls may hope. Among those risks:

1. RHI has a high degree of SMB exposure at ~80% of the customer base. Ex-Protiviti, small businesses are the main customer base for temp and perm placement. This presents distinct challenges as SMBs may retrench, rehire furloughed workers first or, in some cases, close altogether. 

2. Pre-COVID, the environment was incredibly favorable for RHI (probably more so than any prior peak). Penetration of temps was at a record level (looking at temps relative to total non-farm employees), as was small business optimism. As a result, RHI benefited from several years of strong bill-to-pay spread inflation that is likely to reverse if SMBs remain in uncertain territory. 

3. In addition, RHI has a greater reliance on temp to perm conversion fees relative to prior cycles. This is a fee that RHI collects when a temp gets hired by a client as a new FTE. Such fees are virtually all margin. While they’ve already been declining, it’s not hard to imagine these falling much further. Management has commented that temp to perm fees have been ~3-3.5% of sales YTD relative to ~2% last cycle. While they don’t tell us the exact margin, I estimate that these conversion fees account for anywhere from 30-50% of EBIT. 

4. Finally, the business mix at RHI has changed this cycle such that Protiviti (risk consulting) now accounts for 20% of sales, up from 12% in FY07. Protiviti has a tougher time slashing costs in a downturn as it relies heavily on senior partners with strong client relationships. As such, Protiviti saw the biggest declines in EBIT last cycle and was the only segment with an extended streak of negative margins. While it is a larger business today and YTD results have been good (seemingly a function of business booked pre-COVID), risk consulting faces potential headwinds going forward given that a lot of the work has historically been done face-to-face. 

The last thing I would note is competition. This may be the most interesting point and it’s particularly relevant in the current environment with such an increased adoption of technology. There are a growing number of SMB-focused, bookkeeping start-ups. And they are doing quite well. Among the bigger names are: Bench, Pilot and Botkeeper. These are all software solutions that use some form of AI to reduce bookkeeping times and, as you might expect, are significantly less costly than hiring a temp. These are all VC-backed and growing quickly. Bench, for example, already claims to be North America’s largest bookkeeping service. I have not seen their recent growth rates but I would imagine that more SMBs are considering switching in the current environment if it could save them money. If you review some articles online, you’ll quickly find references to highly automated services “flooding the market” and comments about “transactional accounting becoming a commodity.” This is clearly a longer-term risk for Robert Half.

RHI has historically traded at 7-10x prior peak EPS when coming out of past recessions. I’m looking at ‘90/91, ‘01/03 and ‘08/09. Clearly, multiples are higher today; however, RHI also faces new challenges and I’m skeptical that it will recover as quickly in comparison to prior cycles. Nevertheless, I use 10-11.5x on FY19 “prior peak EPS” of $3.90 to get to $40-$45. You could do the same exercise with EV/EBIT and arrive at a similar conclusion in terms of value.

In sum, RHI is a low margin, low growth business with structural headwinds. It’s a  hyper cyclical business that will remain under pressure if unemployment is elevated and it faces a number of unique challenges relative to prior cycles - among these are heavy SMB exposure and increasing competition from technology startups. There’s no debt and it’s well understood that earnings will decline but I expect the short to play out as investors realize that hopes for a quick recovery are unlikely and Street numbers for FY21 move lower.

This report (the “Report”) with respect to Robert Half International Inc. (the “Issuer”) has been prepared by the author (the “Author”) for informational purposes only. The Report contains certain forward-looking statements and opinions which are based on the Author’s analysis of publicly available information believed to be accurate and reliable. While the Author believes that such forward-looking statements and opinions are reasonable, they are subject to unknown risks, uncertainties and other factors that could cause actual results to differ materially from those projected. The Author has no obligation to inform readers of changes in such forward-looking statements and opinions and no warranty is made with respect to the accuracy or completeness of any of the information set forth herein. 

As of the date the Report is published, the Author and/or certain entities (the “Entities”) affiliated with the Author hold a short position in the securities of the Issuer and therefore have a financial interest based on changes in the price of the Issuer’s securities. The Entities may increase, decrease or otherwise change their position in the securities of the Issuer based on changes in market conditions or other analysis. Neither the Author nor the Entities undertake any responsibility to inform readers of changes in such position. 

Nothing in this Report constitutes investment advice. Readers should conduct their own due diligence and research and make their own investment decisions.

Catalyst

• Unemployment remaining elevated
• SMB woes
• Further in-roads from new competition
• Continued declines/longer road to recovery, resulting in Street numbers coming down