Summary
- The HR services industry is an interesting proxy for the whole economy.
- The industry is highly competitive and fragmented and has seen major player struggle to grow.
- Randstad N.V. has been the only major player able to consistently grow and become more profitable.
- Adecco Group AG is still below its 2017 levels.
- In this article, I share my new ratings based on the recent price surge both stocks have experienced.
Introduction
The labor market is still hot and tight, and in the past few months it has happened more than once to see a labor market report that shows resilience and strength. Though these are usually positive facts, in today's environment investors fear such reports because they may delay the much-desired Fed pivot.
I regularly take a look at the HR services and employment industry to see how the main players are performing and to gather some extra data about the economy and its trends. According to Randstad, the global HR services market was worth in 2022, around €476 billion ($508 billion).
The industry is highly competitive and fragmented. This creates a situation where the big players need to rely more on acquisitions to grow rather than betting on organic growth. One of the industry's advantages is that it requires very little capex. On the other hand, EBITA margins are usually very low and usually are in the range between 3 and 6%.
In this article, I would like to provide a follow-up, updating my research on the two main European staffing agencies: the Swiss Adecco Group AG ( AHEXY , AHEXF ) Group and the Dutch Randstad N.V. ( RANJY , RANJF ).
Summary of previous coverage
A few months ago, I initiated my coverage on the Adecco Group, the Swiss HR company offering temporary staffing, permanent recruitment and training services to employers. The Adecco Group operates in Europe and North America and has three divisions: Adecco, LHH, and Akkodis. The company generates 61% of its revenue from Europe and 17% from North America. Its most important service line is flexible placement, which accounts for temporary staffing.
I argued that it could be a good investment opportunity given the fact that the stock was trading at its (up-to-then) 2022 low. Since then, the stock actually traded down a bit further to then recover. It currently is in the black by 7%. I showed how, although the HR and employment services industry can be hit during times of economic downturn, Adecco could be a offering a good entry point for investors who wanted to build a position in a stock that priced in a lot of pessimism. However, I also warned that Adecco has been a stagnating company for more than a decade, alongside its peer ManpowerGroup Inc. ( MAN ). Therefore, the real attractive fact about Adecco at that time was its price level, more than its growth story.
On the other hand, Randstad has grown to become the industry leader, with the acquisition of Monster Worldwide in 2016 and its revenue and gross profit picking up pace to the point that in 2017 it surpassing ManpowerGroup and Adecco. In my last article, I showed how the Dutch company had achieved better quarterly results. In fact, Randstad's revenue was €7bn, up 12% YoY, with a gross profit margin of 21%, while ManpowerGroup's revenues were $4.8bn, down 7%, with a gross profit margin of 18.3%. Randstad outperformed ManpowerGroup in EBITA margin and net income growth. The key driver of Randstad's growth are currently two divisions: Inhouse Services and Randstad Professionals, which respectively focus on managing a fluctuating workforce and middle and senior leadership positions.
Adecco's results
Adecco recently reported its Q4 and FY results .
Its revenues increased by 13% YoY, reaching €23.6 billion. Gross profit came in at €5 billion and increased 16% as reported and 6% organically, making the company achieve a 21% gross profit margin for the quarter and the year, up 60 bps YoY. As we can see, revenues are organically growing quarter after quarter and so is the EBITA margin. However, while the former is trending upwards, the latter is not, showing that it is not clear if every euro of additional revenue will really become more valuable or not in the future.
Now, all eyes were on the impact of the AKKA acquisition, a company providing engineering R&D services in the smart industry market. In fact, amortization of intangible assets was €22 million higher in Q4 YoY due to this acquisition. This also had an impact on operating income, which was 41% lower because of this.
As the company reported, the new Akkodis division reported strong performance, with both revenue and EBITA margin growth of 6 and 7.1% respectively.
Akka brought in around €450 million of revenue, and it was already EBITA and EPS accretive in the first year of its acquisition.
Overall, the company performed reasonably well. However, though these years have been great for staffing agencies, Adecco still isn't above its 2017 revenue levels, where its revenue was €23.6. However, it has become a more profitable company, with gross profits at €5 billion versus €4.3 achieved in 2017.
In the meantime, Adecco has confirmed its dividend, proposing to pay in April CHF 2.50 per share, composed of CHF 1.85 gross plus CHF 0.65 from reserves not subject to the Swiss withholding tax.
While in my past article I still had some confidence in Adecco as a reliable dividend payer, I am beginning to change my mind a bit. The Akka acquisition made Adecco reach a net debt/EBITDA ratio of 2.5 when just a year ago it was 0. The company has said it will be committed to bringing back this ratio and this will make it use its free cash flow. It makes sense to reduce its leverage, but the dividend won't be supported as much as before. In fact, the company is already using part of its reserves to pay out its dividend. This is also done to have a part of the dividend not subject to the withholding tax, but, still, a dividend paid from a company's reserves is not the best dividend to look for.
In addition, the payout ratio is currently at 75%. A bit too high for me, especially if Adecco needs to complete further acquisitions in order to grow. According to Seeking Alpha, Adecco's dividend grade is an F, which makes the company likely to cut its dividend .
With big-tech already laying off workers, it is reasonable to expect that this year the labor market will be a little bit weaker. I am not forecasting a collapse, but some weakness. This was somewhat confirmed during the last earnings call , when Adecco's management actually confirmed that January was a slower than expected month. In addition, during the call, most of the participants questioned Adecco's management about SG&A expenses and, more in general, about cost management, as if the general concern was to understand whether or not Adecco can manage effectively its low margin, higher debt situation.
With the recent bid up in price, I see Adecco Group AG close to its current fair value, but the situation seems to be a bit deteriorating, and I am inclined to think Adecco is currently a stock where it would be wise to take profits and move on to a more interesting and more appealing investment.
Randstad
Randstad delivered a solid 2022, with revenue of €27.6 billion and underlying EBITA of €1.3 billion and a net income exceeding €1 billion, as shown below.
What I like about Randstad is its consistency in become more profitable, though it operates in a low-margin industry. In fact, while revenue increased 12% YoY, gross profit increased 17% YoY and net income saw a 21% surge. Free cash flow increased by 25% to €739. At the end of the year, though its EBITA margin shrunk from 4.4% to 4.2%, its net income margin actually increased by 30 bps, moving up to 3.4% from 3.1%.
What is driving Randstad's increased profitability is its shift from staffing revenues, which are almost flat YoY, to other sources of higher margin revenues. Therefore, we see that the in-house, the professionals, and the global businesses division have grown more than staffing, pushing Randstad's profitability upwards.
Meanwhile, the company keeps on having a very low leverage ratio of 0.6 net debt/EBITDA, though it hasn't been idle from an acquisition point of view.
Thanks to these results, Randstad will increase its dividend by 30%, paying €2.85 per share, which is in line with Randstad's policy to return 50% of adj. net income. It has also approved a buyback program of €400 million over a period of 17 months, starting end of April 2023, something rather new for Randstad, which is used to keeping its share outstanding count quite flat. Between dividends and buybacks, we are at an 8% total return.
Overall, however, the company plans on returning €200 million more compared to its free cash flow. On one side, it shows Randstad's strong balance sheet (stronger than Adecco's). On the other, an analyst during the earnings call addressed this issue pointing out that this could somehow hinder other M&A activities in the pipeline. Henry Schirmer, the CFO, replied in this way
When we do capital allocation decisions, then of course, the first look is always to support our organic growth, our strategy, and what we potentially have in mind as far as M&A is concerned. We are predominantly -- as part of us actually will continue to grow organically, but supported by programmatic M&A, as we always said. And with that kind of proposal, we have everything we want to do as far as firepower is concerned. Why more than cash flow generated? It's just a function of starting that consideration with kind of low leverage ratio of 0.2%. So that is -- that's the main reason.
I think the answer is fair and well-supported by Randstad's financials. So, for this year, we can give it a pass, even though my readers know I am not particularly fond of this kind of operations as I want to see the annual free cash flow supporting shareholder returns to the point that, if necessary, a company can pay a special dividend when it feels it has too much idle cash on its balance sheet. Randstad currently has a little over €200 million in cash, so it is not exactly in the position to hand out €200 of excess cash. Mr. Schirmer let us understand the company can increase its leverage ratio a bit, so it will issue a bit of debt to fund this program. With interest rates rising, it is not the move I'd prefer, but, as I said, given Randstad's solid position, I can accept it for now.
Regarding the outlook for this year, Randstad too reported a softened economic environment across its markets which led to lower hiring activities. This slowdown continued into 2023 and Randstad's January organic revenue was modestly down year-over-year. We will see if this will lead to margin compression or if the company is carefully managing its headcount and its costs to keep its profitability at the top of the industry. Mr. Schirmer talked a bit about headcount coming down, but that is offset by wage inflation.
Overall, I still see Randstad N.V. as the better pick in the industry. However, the stock has had a big recovery in the last few months and it is now trading above €60 the upside has shrunk. With a weaker guidance, I don't think this is the right moment to add. I personally recently took my gains on the stock and I put it back on my watchlist to see if it trades down and becomes more attractive. Trading close to a 12 P/E and at a P/FCF of 10, it is on the threshold of being expensive for a stock in such an industry. This is why I revise my Randstad N.V. rating to hold, from the buy I previously had.
For further details see:
The Grower And The Staller: Adecco Vs. Randstad