Parity Group Profit Warning: Shares in data specialist recruitment company Parity Group (LON:PTY) fell in early trade today as a trading update revealed that it would not meet previous guidance owing to staff shortages. This share price fall was a slow burner, with initial falls being modest but a further drop occuring after lunch. However with the share being very illiquid, this comes as no surprise. Longer-term movement shows this to be par for the course:
With no dividends to speak of, this may have a been a relatively unhappy ride for longer-term holders, as the company has been listed for some time. Indeed, the recruitment industry itself has been the source of profit warnings for some time. Companies such as Staffline, Empresaria, Hydrogen, and Gattaca have all warned in the past. This is perhaps no surprise as recruitment companies are much dependent on the trends at the time.
Parity may argue that they have sought to protect themselves against this. They have a data services consultancy division alongside their recruitment division. However, the pandemic affected them greatly. Revenues were already declining prior to this, spurred by the loss of a large public sector contract. By 2020 staff numbers had dwindled to 44, down from over 100 a couple of years before. This in part is a reason behind today’s warning.
What did the Parity Group profit warning say?
This started out in a rather frank manner:
Trading in H1 has been impacted by underinvestment in the core recruitment solutions business over the last two years and the failure to develop a sustainable and scalable consulting business. As a consequence, the Group is revising its outlook for FY 2021 and will focus investment in the near-term on restoring capability and capacity in its core recruitment solutions business, especially in sectors where market demand is both strong and resilient.
These markets appear tough for a small player to crack, as the consultancy business will contain some real heavyweights. The company also notes that due to its public sector exposure, it was insulated somewhat from a downturn as these services continued. We also know from the latest news that there is something of a jobs boom going on with record high numbers of vacancies. This should be good news for recruiters, but in this case no:
As markets have reopened in Q1 and Q2 2021 and activity has increased, it has exposed the underinvestment in the core recruitment solutions business, leaving the Group unable to take advantage of the rising tide of opportunity and vulnerable to higher attrition in its contractor workforce as contractors have sought fresh opportunities.
At least this is quantified in numbers:
For FY 2021, the Group now expects revenue to be in the region of £47.6m, net fee income (NFI) to be £4.1m and adjusted EBITDA to be a loss of £100k, with a loss before tax of £750k (before non-underlying items).
No references are given, and you have to look at a brokers note to find what previous expectations were. This projection was £66.5m, with £29.5m in the first half, so we can presume that something has gone badly wrong here. This seems to be a bit of an own goal, as in their previous results in April they stated that the pandemic easing would give opportunities for further growth.
Parity Group: The Business
Parity epitomises many of the businesses in the financial sector: a very large turnover for a relatively small amount of profit. Gattaca (who also warned on profits) had a headline margin of under 1%. This in itself may be slightly unfair, as the recruiter gets paid by the client and then as to in turn pay out most of this to the employee. So many refer to net fee income, which takes out this cost. It is for this reason why the Stockopedia number is a bit confused:
2017 was the high point here; a net profit over over £2m was booked, albeit £0.5m of this was in the form of a tax refund. The company is not acquisitive, and has very little in capital expenditures, either tangible or not. With no dividends being paid, these monies were used in a rather conservative way: debt was reduced. It also had a pension deficit, but this was wiped out and is now in surplus.
The actions have actually been pretty valuable in retrospect. Mainly as a result of the reduction in debt, the cash position has stayed positive despite 2020 showing a sharp decline in both revenues and net fee income. Those cost savings also led to the 2020 year (which ended in December, so mostly affected by the pandemic) to be not fatal to the company. It booked an operating profit of £23,000, however finance and taxation costs meant a net profit (and cashflow) of £-0.5m.
Some caution is needed as there have been big swings in capital movements. Trade receiveable days have fallen over the years, going down to 30 days from 52 in 2017. This may not be sustainable if business picks up. Payables, on the other hand have stayed relatively constant, also around the 30 days mark. This is pretty understandable given that people won’t stand for their wage checks being strung out.
The company used to report in both the recruitment and consultancy segments, however this has been changed and now reports along the private and public sector lines. Here, public sector dominates the billings, with roughly 75% of business being accounted for in this way. There is country concentration (all based in the UK) and also customer concentration to be aware of: the two bigger customers account for over 30% of business. Consultancy was previously a small part of revenues, and from the latest comments seems to be further marginalised with the extension of its add-on services being recruitment based.
Management appear to own very few shares here, with the bulk of their interests in share options (potentially diluting the count by another 10%). However, if these recent share price falls are sustained, it appears that the conditions for most of these to vest will not be made.
Is the Parity Group profit warning a buying opportunity?
For me, I am not entirely sure. This isn’t something I have much interest in, either the company or the wider sector. One thing that seems likely is that this will be another year of change at Parity. The higher margin consulting work may be difficult to get in volumes that really make a difference to profits. However, taking on more recruitment work should be more straightforward, and investment could simply mean taking on more staff.
However, even on the previous forecast revenues of £66.5m, profits before tax are set to be very modest at £0.3m after adjustments. In terms of cashflow, absolutely zero. The company appears to have an asset factoring facility against its receivables, however this is relatively expensive to run and in recent years the interest payments have been larger than the profits.
So given that revenues are set to be much worse this has an effect on cash, and the brokers have revised this to -£1.4m. The cash position at the end of last year indicates that this is no problem. But will there be enough to do this and invest into the core business? What if the investment is made and the benefits do not materialise, or if winter sees another lockdown? To me, that’s sailing close to the wind. An equity raise could be a viable enough option; but it seems only a modest amount could be raised at current valuations.
This isn’t a basket-case. But there are a lot of unknowns for me. It could well be the case that like Hydrogen, it makes a good acquisition target for another business who may have synergies. 2/5.