,Staffing specialist Empresaria (LON:EMR) today dropped to a new share price low. A trading update warned that Brexit was causing problems in its business and as a result, profits would be below previous expectations. The market did not like the latest Empresaria profit warning:
The share price reaction has since recovered some since then and is only down 3.5p. The bigger picture (as for many profit warnings) is that of decline: the price topped 170p in June 2017 but since then it has fallen steadily to reach a new low today.
Empresaria describe themselves as a diversified staffing group and in some sense they are right. Geographically their income is split between North America, Europe, the UK and Asia Pacific across a diverse range of brands. They also recruit across a wide range of job roles, and are not tied to one particular industry. So far this has proven to be a quite resilient business model and they have delivered consistent, if unspectacular results.
What did the Empresaria profit warning say?
The dreaded Brexit word is mentioned in a trading and operational RNS today:
At the time of our interim results we expected to meet market forecasts. We identified that our Engineering sector was experiencing an adverse impact from Brexit and challenging market conditions and we expected the second half to remain difficult. Despite actions taken to turn the business around, the UK Engineering business has experienced further material declines in revenue with the ongoing impact of Brexit, the insolvency of certain key clients and the early closure of major projects. We now expect the Engineering sector to deliver a full year adjusted operating loss of approximately £1.5m. Due to this further deterioration in trading, a material restructuring of the UK Engineering business is underway and we expect this to be completed before our next scheduled trading update in January.
At the last broker update in August (available on Research Tree) we were on target, so these items must have happened fairly recently. The Brexit landscape appears to change on an almost daily basis, so there could be some truth in this.
As we also know, the latest season of Brexit has now been extended to 31 January, 2020 and it could even be the case that this extension sees another extension. Thus, we may be seeing another profit warning sometime soon as poor conditions become contagious to other sectors:
The impact of Brexit has increased in the second half and with the decision to delay Brexit again, we anticipate further months of related uncertainty in the UK. In addition, the German automotive sector slowdown has continued to impact our European operations. The impact of these challenges has largely been offset by the positive growth seen in many other businesses in the Group, but the net impact at the full year is now expected to be negative.
We also have a projection on what this means for the full year:
We anticipate that the Group’s full year adjusted profit before tax is now expected to be at least £9m. Significant actions have been taken in the impacted businesses in the UK and Germany to right size their cost base with the full benefit of this expected to come through in 2020.
There appears to be few adjustments, save for amortisation of intangible assets. A previous broker note put this estimate at £11.4m, so this is a fair sized miss.
Empresaria: Balance sheet woes
Generally I am not a fan of recruitment style businesses. They are mostly replaceable and competitive advantage is difficult to get, and even harder to protect. Many companies recruiting have a good choice of firms to use. And they hardly have exclusive access to individuals. Thus it could be said that much of the advantage lies in the people. These could easily leave the company and work for a competitor at short notice.
With such competition, I see it as quite difficult to add value in these businesses, although some do such as FDM. Margins here are quite thin as shown:
This does not leave much room for error if things go wrong. Many firms protect against this by having many different sectors and countries, as Empresaria do. Having known people who work in this sector, it is also fair to say that staff are pretty easy to get rid of. But looking at similar companies, these margins are fairly low. Robert Walters and Hays manage around 4%, Pagegroup do even better in excess of 9%.
It should also be said that general market sentiment affects all recruitment companies. A profit warning in one tends to affect the rest in similar ways, due to the way they are all serving more or less the same customers. Gattaca and Staffline have warned in the past year.
The main gripe I have with Empresaria is the balance sheet. Growth here looks impressive. Turnover is set to double in size from 2013-2019. But as we can see from their website, there have been plenty of acquisitions along the way, both outright and minority stakes. Some £23m has been spent over this period, which roughly cancels out the corresponding net profits.
At least the board have had the sense not to pay out generous dividends during this period. It still means that net debt has not gone anywhere, and in fact is worse off. The last accounts showed £37.2m of borrowings. This may not seem serious relative to a £11.4m projected adjusted profit. The group pays a relatively high tax rate and also some profits are also attributable to non-controlling interests.
This has resulted in some rather weak balance sheet metrics. Net tangible asset value is negative, at -£8.5m, and the current ratio of assets/liabilities is just 1.07. £51.4m of the £82.7m in current assets are filed under receivables, and some of these may be under pressure if the current trading position persists. These liabilities are listed as current as well, and have to be re-negotiated this year. Balancing against this was a cash position of £25.8m.
Is the Empresaria profit warning a buying opportunity?
The market cap of Empresaria is currently £20m. This puts it on a very small multiple even accounting for the tax and minority interests. It is also fair to say that the past management of the company has been good. It looks as if they have integrated their many acquisitions fairly well.
Going against this is the weaker balance sheet going forward into a period where there will be plenty of turbulence.There may be a great deal of uncertainty on how long it will last. A really disastrous year is unlikely to happen. Then again if it should occur I might think Empresaria may not survive without some Staffline-style measures.
Also going against this is that while the valuation is cheap, there is a reason for this. Many recruitment companies do not reach double figures for price/earning. There are plenty of them to choose from in the stock market.
A broker piece in August put fair value at 100p, this should be a little less now due to the profit warning but I think sums it up quite well. At the current price risk and reward are quite fairly balanced. It could all go wrong, but then again the company may be attractive for someone to acquire. 3/5.