RCRUY - Recruit Holdings: Facing Significant Headwinds And Not Undervalued

2023-12-03 05:49:08 ET

Summary

• With moderating growth in the global job market, we believe Recruit will face headwinds into FY12/2024.
• Changes to job listing pricing structures, a contracting workforce, and limited recovery from the tech sector pose challenges.
• Recruit appears fairly valued, trading on PER FY12/2024 27.0x and a low dividend yield of 0.5%.

Investment thesis

Recruit ( RCRRF ) appears fairly valued given limited prospects for organic growth in the face of a moderating global job market, changes in job listing pricing which will limit monetization opportunities, and limited recovery prospects in key tech sectors that had been core drivers in the last 3 years. We reiterate our hold rating.

Quick primer

Recruit Holdings is a Japanese media company with a focus on HR with online job listings (HR Technology), lifestyle media and marketing (Matching & Solutions), and temporary staffing services (Staffing). HR Technology is the core earnings driver, contributing approximately 70% of total adjusted EBITDA, with the remaining segments at 15% each. 55% of total sales are derived from international markets. The company has embarked on a successful globalization strategy since 2010. It has assets such as the job search engine Indeed (acquired in 2012) and job and company intelligence site Glassdoor (acquired in 2018).

Key financials with consensus estimates

Assessing the outlook

We review our previous hold rating from April 2023 . Our view is that the recruitment industry faces growth challenges, particularly for the major players who have already established global reach, high levels of digitization, and social media engagement. Putting macro headwinds aside, we believe the industry faces a talent shortage for key sectors such as hospitality and services, diversity and inclusion challenges, the shift to remote work and hybrid models, and changes to job advertising pricing structures (from price per click to action-based models). As market needs change, we are unsure whether the incumbents are changing to meet new demands.

Recruit is seeing lower earnings visibility in its overseas markets, particularly from changes in job listing pricing structure (to Pay Per Started Application) and staffing, while its home market has been relatively robust with a tight labor market and demand for personal services. We will assess the outlook for 2024, looking at Recruit group company Indeed's 2024 US Jobs & Hiring Trends Report as a yardstick for the medium term.

Challenges both short and long-term

Despite focusing solely on the US market, we believe Indeed's report highlights three key challenges. Firstly, employer appetite for new job openings has moderated compared to the last few years, rising above the pre-pandemic peak seen in February 2020. We believe this signifies that for the time being, job vacancies have been adequately filled, and perhaps more of a concern is that employers are rethinking their hiring plans in the face of slowing economic growth and macro uncertainty.

The second issue is the long-term demographic headwind over a contracting labor force, which will result in falling demand for work and recruitment services. Whilst the US has been able to counter this impact via strong immigration in 2023, we believe this is not easily repeatable in other regions such as Europe and Japan.

The third issue is related to the first and has been a key economic growth driver - the drop experienced in job postings in the tech sector. Despite heightened excitement over AI, we believe that key technology-focused sectors will remain relatively weak in recruitment, which will limit any recovery or growth re-acceleration profile for the job market into 2024 - these include software development, information design and documentation, and mathematics. We also feel that sectors such as banking and finance, and R&D will remain under pressure.

Recruit's response

Whilst Indeed's report conclusion is of cautious optimism into 2024, Recruit overall does not appear strongly positioned to counter the challenges we have highlighted. Gaining market share appears to be the core activity to counter moderating job listing volumes and weakness in demand from key market sectors. However, at this point, there is no indication from the company that this is a strategic objective.

The company's capital allocation policy currently prioritizes share buybacks, recently conducting a 0.77% share tender offer in October 2023 . Despite being cash-rich, the management has stated that the opportunity for ' any gigantic opportunity ' is not high. With material acquisitive growth not being a viable option, we believe it will be difficult to generate market share gains given the potential for a deterioration in market conditions. The company also appears to be assessing the potential for further restructuring in the HR Technology segment if growth prospects fall short, even after a headcount reduction in March 2023.

The shift in job listing pricing structure (to Pay Per Started Application from Pay Per Click) is expected to cause short-term negatives for earnings visibility. Whilst the company is aiming to improve service quality, it admits that revenue generation is superior with the Pay Per Click model and that it is prepared to lose market share in the short term to develop stronger customer relationships. Whilst this approach may pay off in the longer term, we believe that the combination of moderating market demand and lower monetization opportunities will be detrimental to prospects for FY12/2024.

Valuation

On consensus forecasts (see key financials table above), the shares are trading on PER FY12/2024 27.0x, free cash flow yield of 4.3% and a low 0.5% dividend yield. We believe consensus numbers are relatively bullish (we think flat growth at best YoY), hence current valuations look fair and certainly not significantly undervalued.

Thesis catalysts

The global market will begin to show signs of slowing growth into FY12/2024 given relatively high hurdles, limited hiring budgets by enterprises, and workers becoming more conservative and not job-hunting in a period of economic uncertainty.

Limited organic growth prospects result in valuation multiple contractions.

Risks to the thesis

The global economy demonstrates re-accelerating growth YoY, and enterprises become more confident to invest and expand their business activities in the face of renewed demand.

Recruit decided to conduct a major M&A to expand its global footprint further.

Conclusion

Recruit shares have held up relatively well over the last 12 months, and capital allocation to share buybacks will provide some support to the share price. However, with a low dividend yield, there is limited incentive to remain long-term shareholders, and we believe it is too early to become bullish on a cyclical company experiencing limited organic growth prospects. We reiterate our hold rating.

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