Whilst the recruitment sector may not be to every investor’s liking, there are nevertheless some quality players on the market that can prove highly rewarding over time.
My own preferences across this space are for Robert Walters (RWA) and SThree (STEM) with the latter in particular, possessing a number of positive attributes.
STEM, is something of a specialist operator, focused across Technology, Life Sciences, Engineering and Mathematics, where it excels as a global operation.
Despite the current economic climate presenting significant headwinds for the many including not surprisingly the likes of recruiters, STEM has been faring well enough and has very recently delivered what were pretty resilient numbers in a pre-close Trading Update to the market.
The performance was particularly positive, given that the period concerned was up against a previously extremely strong comparative that had delivered record numbers.
Following the update, this sees the figures coming out in-line with the market expectations, where Broker Investec has revenue of £418m forecast, providing for normalised pre-tax profit of £71.6m which will give EPS of 37.7p.
That sees the stock at the current price of £4.17p standing on a PE of 11, which looks pretty reasonable when compared to sector peers, particularly given STEM’s growth traction and specific market focus.
However, in isolation the PE measure arguably isn’t always the best way to value these types of businesses, particularly given the potential for cyclicality.
That said, it is also worth factoring into the mix that STEM enjoys a very strong and solid net cash position, along with paying dividends where the full year 2023 total pay-out is pencilled in at 15p per share, which should move to a progressive path going forwards.
One of the most notable and positive aspects of STEM’s ongoing solid performance has been the concentration and highly successful delivery on the contract element of recruitment, which eclipses other UK quoted players.
In order to hear more on this and other aspects of the business along with the prospects ahead, I caught up with CFO Andrew Beach on the morning of the update last week.
Beach was quick to fill me in on just how STEM’s contract concentration works, which notably, now accounts for a standout 82% of the total of the group’s net fees.
Although and perhaps understandably investors may perceive the contract element as being brief or limited to a short interim period, it is actually anything but that.
“Our contract business is not about temping or a short-term thing” Beach explained, rather, he added that they are dealing with very high end, highly skilled people placed within companies and for what can prove lengthy contracts.
“It is really a lifestyle choice for the contractors who have very niche and short supply skill sets that they know, and where they enjoy going from company to company, helping on a specific project”.
This, I am told as an example, could be something like working on a wind farm for a nine-month contract with a player such as BP, before moving onto another project that could be with the likes of Shell or other major blue-chip players.
Given the wide spread and quality of the high-end markets and specialist skill sets of the contractors aligned to STEM, it is perhaps easy to see just why the business has been performing so well over a period of time.
However, I have to ask as to whether an economic turnaround could see the current trends reverse, with perms perhaps subsequently featuring more positively to the detriment of contract where the company is heavily concentrated.
Beach immediately allayed any fears on this important aspect where he commented, “no, we don’t see that changing, in fact, we see more people, as lifestyle changes and increasing flexibility bring a shifting to contract as opposed to perm as an ongoing megatrend.”
There is, though, also within the contract aspect of recruitment what is known as a statement of work (SOW) which provides the employer with flexibility to only employ a contractor for the duration of a specific project and this can in some cases prove detrimental to both the employee or recruiter.
Beach says that it isn’t an area which STEM does very much of at all. “It is something we have looked at, but no, for us it is very minor, so more often than not a client will come to us, or we will go to them, where we are what you would call candidate driven.
Our relationships are really strong with the contractors or candidates where we are trying to be their lifelong career partner, as we know just when their role is coming up, so then we are out fishing for the next job.”
In terms of the dynamics of the substantial contract business that has been and will continue to drive STEM further forwards, Beach explained, “the contract business is great for us and it is more complex than perm. It is harder to deal with, so you need a back-office function that can handle the legal position of dealing with the contractor, along with time sheeting and invoicing to the client.”
Going further, he added, “it really is so much more complex and in that there are very high barriers to entry, where being high, you need to pre-fund the contractors a bit.” This aspect equates to a time lag that comes about as contractors invoice STEM, who then in turn will invoice the employer, thus resulting in what is effectively a cash flow gap. “You actually need a decent sized and scaled business that can afford that working outflow of capital in the short term”, Beach explained.
Given the complexity, but within that the mutual benefits of the contract structure, the CFO said that people very rarely leave STEM to move into perm and that plays out well for all parties concerned.
Speaking of the financial elements of the model, he continued, “it also makes us more money over the life of a contract, so for every one placement that we place across the life of a contract, we make about 40% more money and our average contract length is about forty seven weeks, which also gives us really good visibility as well.”
Overall, the CFO said that the process works extremely well for the company with that positive level of visibility ahead and the ability to look at the market trends, which also sees it actually proving less cyclical too.
Currently, the contract order book at STEM stands at a very impressive £185m which Beach said is pretty amazing and provides a solid underpinning of the business moving forwards.
As a global player supporting many specialist technical fields, STEM is able to enjoy diversification and balance across its operations, with some areas and aspects providing sizable uplift even if others experience some contraction as the current climate dictates.
In relation to the 2023 performance, Beach said that across engineering which performed very well, the main thrust has been energy which within that they saw quite an increase across renewables.
Indeed, renewables year-on-year has grown 28% which now accounts for 10% of their whole business not just the engineering aspect and which looks set for further upside momentum given the ongoing energy transition shift.
“We work with big energy companies on major plants, such as wind farms and solar panels, which is particularly prevalent in the Netherlands, as they are leading the way in renewables.”
Spain also recorded an excellent result in geographic terms, but in the bigger picture it is small in terms of numbers as it is off of a relatively low base. That said, it has seen growth across technology related business where it is positioning itself as a new tech provider in the employed contracted model.
Traditional energy has also been positive for the company such as in the UAE, which Beach says is also now slowly transitioning to renewables.
STEM is certainly and importantly highly active across the world, with the major countries being Germany, Netherlands, US, the UK and Japan where those five alone represent 74% of the global STEM markets. Add into that mix another eight or so countries, then you move to 85%, which translates into the company already being in what Beach describes as the hot, hot markets.
Although the company is clearly active across each of the major and supporting countries and regions, the CFO informs me that its market share is actually tiny in the big picture. Expanding on this he said, “there is huge potential in the markets we are already in, as our average market share of STEM recruitment in those we serve is around about 2% as it is a very fragmented market. Therefore, we think that doubling down on where we are, means we have lots of growth opportunities.”
Despite the business being global and having a worldly feel, Beach talks in terms of things actually being very regional in an operational way, as he explained.
“Recruitment is actually very local, very regional, you don’t really get that many global remits, so it's all down to countries, but even in countries it’s then all down to skill sets.”
What that means is that it translates into some very big businesses on a regional level, which in turn, brings about huge growth opportunities from what can be very big business clients.
With that in mind, Beach adds that as part of the growth strategy over the coming years there could be some M&A, where he commented “it isn’t an absolute must do for us as we have got a lot of growth opportunities anyway. But, if we could accelerate our position in any particular skill set or market with a sensible modest sized bolt-on, then we would consider it.
A random example is, in the US, where it is our lowest market share, but yet is the biggest STEM market, so there is huge potential in the US.”
As part of the ongoing growth drive, the company invests heavily into the business and it has developed its own technology platform, which Beach says has been a process of revolutionising their tech processes and this has already been successfully rolled out in the US.
This will lead to new and improved ways of working with efficiencies too, which he adds, “when we roll out that tech platform out to the whole group which we hope to do at the end of next year or the beginning of FY 2025, then we will have a pretty neat platform on which to drive synergies and bolt-on and we believe we are leading the market with this tech.”
Although the current economic picture sees the sector enduring a modest decline, Beach says that at STEM, that decline has slowed recently and as it follows on from previous record years he remains positive on the future for the growth of the business.
Despite having a heavy focus on the contract aspect of the business there was a real positive registered across perm from Japan, which is the only market that STEM really focuses on that aspect of business and this grew by 5%.
In terms of a negative performance across the group for the period, the CFO said life sciences was down 21% but added that it is a great sector to be in and that they are certainly ready for when it bounces back.
All in all, STEM looks, as mentioned at the outset, every bit the quality player across the sector and possesses the ability to prove rewarding over the medium-longer term from an investment perspective.
With a strong presence across key markets, in particular engineering which should see further significant demand from renewables, the company has scope to deliver on the growth front, particularly as economic headwinds dissipate.
For now Investec forecasts revenue next year of £438.8m with pre-tax profits of £79.5m which would give EPS of 40.9p, equating to a forward PE of 10, whilst the dividend is anticipated increasing to 16.3p per share.