Shares in recruitment specialist Hydrogen (LON:HYDG) fell 30% as the group put out a late RNS at lunchtime, rocking investors. The news seemed to have been coming, as the share drifted in the news up to the latest Hydrogen profit warning:
Hydrogen have been listed for some time, since 2006, but the performance of their shares has seen little cheer for investors. The price graph shows that after listing they were above 300p but came down to this level during the financial crisis of 2008 and never recovered after that. We have seen some attempts to grow back but the price has always been slammed back down. The company has good form for issuing profit warnings in the past.
Hydrogen are a recruitment agency. Unlike others who may specialise in sectors, they are cross-sector focusing on mid to higher level roles. Recruitment overall has suffered a very poor year as several firms have found Brexit to have increased uncertainty. This has lead to some firms holding back on employment drives. There may be jobs growth in future, but it is unsure if any of this growth is meaningful for these companies: low-paid, zero-hour roles are not likely to be lucrative any time soon.
What did the Hydrogen profit warning say?
Negative marks for pushing out the RNS at lunchtime, particularly when there was no reason for it. The share price seemed to get wind of this earlier in the day. Further, it is also very brief. We get into the reasons:
As reported in the Group’s Interim Report on 3 September 2019, the Group traded in line with expectations during Q3. Subsequently, trading conditions in two of the Group’s key markets have deteriorated.
These two markets are the UK and Hong Kong. The EMEA/APAC segments make up virtually all Hydrogen’s business, so is likely to be quite relevant. For the UK:
In the UK, demand levels have continued to be impacted by growing political uncertainty. This is now being exacerbated by the impact of the proposed changes to the IR35 legislation on clients’ contract hiring plans.
IR35 refers to new legislation designed to combat tax avoidance by workers. Of course in this time period we have also seen Brexit cancelled. For HK:
In the Asia Pacific region, the public disorder and demonstrations in Hong Kong are now having a material impact on local activity levels.
This tallies up, although I would expect this to not be long-term.
As a result, the Board expects the Group’s full year underlying profit before tax to be below current management expectations.
Hydrogen: One Business, Multiple Challenges
Hydrogen seem to have their hands full at present. This is not a growing business. Profitability has also jumped around:
As we can also see, margins are very thin here. They always are in the recruitment industry, but this is below the level of some of the bigger players. The last set of results was regarded very well by the market. Those gains have since been wiped out and the market cap is very small at £12m.
The business has a record of cash generation albeit in lumps, but this often does not translate into profits:
Part of the reason of this are previous profit warnings which have hit profits by means of restructuring costs and impairments. The last year was good though: a large cashflow allow the firm to pay down debts and pay a dividend. At the time of the last financial statements, the firm is now debt free save for a small invoice discounting facility and the new lease liabilities if you wish to count this.
The solvency looks OK: there is a net cash position, receivables are also in excess of payables. Net tangible asset value is also positive and the whole outfit trades at discount to book value now. The firm also capitalises very little of its spending. Headroom on the borrowing facility is significant: an £18m facility at 1.7% over base rate means it is pretty cheap to borrow. At the interims, the company had performed in line with the previous year.
Additionally this is a group where insiders have plenty of skin in the game: the CEO accounts for over 10% of shares. They have also shown to be active in the market at around these price levels. One senses they are doing a reasonable job in testing conditions.
Is the Hydrogen profit warning a buying opportunity?
Relative to the market as a whole, these might seem good. A quarter of the market cap is in cash, the company should still be profitable this year, debt has been cleared and an ex-cash multiple may be around 4 or 5. But companies in this sector tend to be cheap. Gattaca and Staffline are around this level too. Empresaria issued its own profit warning recently and also sits at a similar multiple.
Even companies that have executed quite well are cheap on conventional grounds. A more diversified Robert Walters sit on a ratio of 10. The whole sector seems hit by uncertainties over the future, but also regulations and accounting issues seem not far away.
The Hydrogen board commented at the interims that they would be looking for acquisitions with their money. They may have to be pretty modest ones at this size. It seems more likely they may be acquired. The much bigger Singapore-based HRNet bought stakes in both Gattaca and Staffline at their reduced prices, perhaps the same could happen here.
This is not a car crash of a share. But I feel that many smaller recruitment firms do not have much of a moat and could be easy to outmuscle and not survive a longer period of depressed margins. For those willing to wait there may be a decent sized dividend, if it is not cut. 2/5.