Shares in recruitment specialist Gattaca (LON:GATC) fell 15% today as the firm issued another warning on profits, citing challenging market conditions. The share price fall actually was not too bad on the day:
In the bigger context Gattaca has been a consistent disappointment. In 2015, the share price was pushing to exceed 600p, but since then it has been a slow lurch downward. With management missing profit forecasts sporadically and having to issue warnings, this has not been a nice long-term hold and depending on the entry point would have seen a huge destruction of shareholder values. The shares sit at a new all-time low, with a market capitalisation of below £30m.
Recruitment companies haven’t had the best of times recently, especially those with a focus in the UK. As a recent research note puts it, there has been a perfect storm of sorts for these companies as Brexit, the General Election, infrastructure cut-backs and a general hesitance among employers have seen several companies warn on profits: Hydrogen, Staffline among the recent sufferers.
What’s gone wrong at Gattaca?
The bad news comes in a trading update released this morning. There is no ceremony and we are straight into it:
Following a review by the Board of the outlook for the business for its financial year ending 31 July 2020 (“FY20”), it now expects the Company’s continuing underlying profit before tax to be approximately £6.0 million, which is below current market expectations*.
An updated broker note (available on Research Tree) is out this morning and quotes these expectations as £10m: so this is a very large miss. We have an explanation:
Gattaca experienced a challenging environment across the staffing market, driven by the economic and political climate in the UK for the first five months of FY20 (August to December 2019) which has resulted in net fee income 11% lower than the same period last year. The market has not recovered as quickly as expected and short-term growth remains uncertain, despite the decisive result in December’s General Election. The timing of UK investment in major infrastructure projects is still not clear and certain manufacturing, automotive and rail sectors continue to be impacted by a lack of confidence. In addition, there is continued uncertainty surrounding IR35.
Perhaps this may explain the rather muted fall in share price: most of these reasons are entirely foreseeable. In addition, industry giants such as PageGroup and Robert Walters were reporting fee reductions from the UK. But unlike Gattaca, this was cushioned by the fact that they have operations abroad which mitigate this. For Gattaca, £613m of their £647m revenues come from the UK.
Gattaca: A continuous turnaround
The figures suggest a good business which has fallen on hard times recently:
But underneath this there has been plenty of change which the figures do not suggest. In fact, Gattaca itself did not exist 3 years ago, as the group was formerly known as Matchtech Group (which floated in 2006). Since then it has acquired several different companies, the largest of which was Networkers. This was more a merger of sorts and was the catalyst behind the rename.
The notable fly in the ointment here was the 2018 results which shows a loss of -£25.3m. This was as a result of a massive impairment charge surrounding the Networkers business. Over £33m was impaired: this was huge in terms of the business representing almost three quarters of all its intangible at the time. The annual report that year described it as ‘resetting the business’.
So on one hand the loss is not as terrible as it may have seemed: £27.4m did not leave the company as a non-cash expense (although the cost in acquiring the original acquisition was real). And it does not do much to hide the fact that momentum in this business appears downwards, with shrinking profits.
It may be worrying that acquisitive companies have given Gattaca a weaker balance sheet, but that is not the case here. With most of its intangibles written off, it still leaves a positive position:
It’s current ratio seems fine as well at 1.63. Most of its assets are receivables, and considering the level of turnover there the revenue cycle is relatively quick. The business is a good cash generator and up until a couple of years ago there was a high conversion of this into profits. So at present, liquidity does not seem a factor.
What about debt? Its acquisitions have been financed by both equity and debt. On this measure, bank borrowings have fallen and some £6m was paid off the pile last year which stands at a net figure of £24m. The decision to stop paying dividends (which was costing £6m or more in recent years) was a big factor behind this, and given the news today it seems that these dividends wont be coming back in the same levels that they were. The Group had £90m in total in borrowings available to it, so clearly there is plenty of headroom.
Are Gattaca shares good value?
The jury is out on this, although no doubt Gattaca will appear on many value screens. With adjusted profits at £6m (and forecasted to increase back to £10m by the broker), the earnings multiple stands at just over 4 on current market capitalisations. The company also is very cheap relative to its tangible asset value. And as anyone who has worked for a recruitment company before will know, it is very easy for them to shed staff. The headcount shrank from 860 to 739 in the last year.
Factors going against Gattaca is that there are plenty of headwinds facing the industry and particularly the UK and engineering segments, which it is heavily concentrated in. The profit warning factors such as Brexit have not abated, and look certain to provide much uncertainty for some time to come. Sector-wide other firms have been suffering as firms take their recruitment and hires in-house, depriving these firms of commission.
So it is cheap, but then again, recruitment firms should be cheap. It is hard to envisage a competitive advantage being built aside from strong customer relationships. Even the successful firms with diversified operations and no debt are not that expensive with ratios of 10-12. None of this describes Gattaca at the moment.
However, there may be support on the horizon. Staffline saw much purchasing of its shares with Singapore-based HRnet acquiring 11.7m shares at 180p, and has a stake of almost 25% of the company (unfortunately for them, the shares have drifted further since). It could be the case that Gattaca present themselves as an acquisition target at this new low price.
At this low price I feel risk and reward are pretty well balanced and I would not like to call it either way. 3/5.