Over the last few weeks, stock markets have been hitting new highs, with cyclical stocks leading the charge. As a consequence recruitment stocks are up 6%, twice that of the market. The turnaround started in the spring of 2012, driven by low interest rates and a wall of cheap money from central bankers. That said the macro picture is improving too. 

Labour data from the US is surprisingly on the upside, and whilst bumpy, leading indicators such as Markit’s PMI (purchasing managers index) and another PMI index, produced by the Institute for Supply Management and covering the US, are increasingly pointing to a benign trading environment in most territories. 

Unsurprisingly, investors first turned to the larger names in the staffing sector. Hays, Michael Page and SThree are (on average) trading on a prospective price earnings multiple of 22x. This is a 59% premium to their average ratings in 2006, indicating investors are expecting a material surprise to earnings on the upside. 

Given recent updates this level of enthusiasm appears a little premature, with net fee income trends remaining negative. For example, Hays has seen net fee income (NFI) growth move from positive 2% in the three months to June 2012, to negative 1%. Similarly, SThree has just reported a 3% fall in NFI (for the three months to February 2013).

Operationally many of the small cap recruiters are outperforming the larger names. For example, Matchtech announced that NFI increased 8% in the six months to January 2013. Hydrogen saw NFI increase 5% for the same period. In both cases the outperformance was driven by a shortage of specialist skilled candidates, notably in engineering and other technical industries.

Despite this stronger operational performance the smaller recruiters have yet to recover their pre-recession ratings. In the 18 months to June 2008, Empresaria, Harvey Nash, Hydrogen and Matchtech traded on a perspective price earnings multiple of 13.7x (simple un-weighted average). This was a 7.8% premium to their larger peers. However, these recruiters are currently trading on an average perspective price earnings multiple of 7.9x. This represents a 65% discount to their larger peers. 

We anticipate this valuation discrepancy may well narrow, driven by investors’ search for value. Indeed recent share price moves indicate this search has begun, with the smaller agencies beginning to outperform the larger ones. For example, over the last four weeks the big three have seen their shares rise 5%, whereas Hydrogen shares are up 11% and Empresaria shares are up 8%.  

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