Stockwatch: This share already prices in significant risk

A positive outcome from US-China trade talks is crucial for this company, but analyst Edmond Jackson thinks that double-digit growth already justifies a higher share price.

The second half of 2018 saw plenty of savage de-ratings, especially among stocks perceived as cyclical – airlines, retailers, house-builders and recruiters – with small caps often bearing the brunt.

Experienced investors will know cyclicals do usually fall ahead of a general slowdown, and also rise in a recession before any evidence that their operations are improving. Small caps can represent value-traps given their tighter market is prone to accentuate swings.

Volatility links to shifting expectations for the global economy

Robert Walters (RWA) a £430 million professionals recruitment consultancy, is a good example.  Well-run with a strong base in Asia Pacific – both the eponymous Robert Walters as CEO and Giles Daubeney his deputy, are Australian – its stock has attracted relatively high price/earnings (PE) multiples since it first floated in 1996. That contributes to volatility if there's a change in expectations.

For an example, look from early 2015 to mid-2016 where the market price rose from about 300p to 475p, then slumped to 250p, despite the table of historic performance showing solidly strong progress during this time-period.

The stock then soared consistently for a 220% gain near to 800p in the middle of last year, at which time I suggested this was linked to optimism over the global economy and quality small caps, leading a "blow-off" in the equities bull market that set up an inevitable reversal.

But was a 40% plunge to 480p - currently 555p - really justified or overdone? Walters' operations offer diversified international exposure apart from the US: during the first half of 2018, 39% of net fee income (the benchmark performance indicator for an agency-type business) was derived from Asia Pacific, 28% the UK, 26% continental Europe and the remainder 'other international'.  

Source: TradingView (*)  Past performance is not a guide to future performance

In a mid-year market context where stocks were frothy, accelerating trade tensions between the US and China during the second half did a lot of damage to expectations for global trade, with uncertainties over Brexit and the eurozone economies not helping either.

2018 ended with fear about how all this will play out, although company trading statements currently affirm little to no change, and some stocks are rebounding sharply.  Instead of a 'Santa rally' in late 2018, markets capitulated, further priming the market for gains in the new year.

Source: Company REFS Past performance is not a guide to future performance

Asia Pacific and Europe drive a record quarter

In respect of Q4 2018, Walters has declared record performance with Asia Pacific growing by 19% and Europe 22%, these regions accounting for 66% of global net fee income versus 65% in H1, although the UK edged up only 2% (i.e. flat in inflation-adjusted terms) and other international eased 2% or 5% at constant currency.

Japan, Indonesia, Taiwan, the Philippines and mainland China all grew over 25% which as yet defies late 2018 signs of consumer/manufacturing decline in China which, it is feared, relates both to trade issues and the efficacy of debt stimulus wearing off.

Optimists, however, reckon China will come up with more enlightened stimulus this year and, while its economy may not grow at exceptional rates of the past, it remains the best prospect for global growth; hence, companies oriented to Asia Pacific should remain a priority, especially for UK investors where Brexit uncertainties cast a pall over sterling and the economy.

Despite recently weaker economic statistics from Germany, Walters' operations here, also in Switzerland, Spain and the Netherlands, increased net fee income over 25%, with record performances also in Belgium and France.  This has a macro upshot too, for unless recruitment is lagging negative economic change, it shows various EU countries doing well. In these circumstances, what motivation is there for the EU to renegotiate Brexit terms like some in the UK government would hope for?

Spain has been characterised as a problem economy, especially by euro-sceptics, and indeed youth unemployment remains high at about 33% versus 32% for Italy and 20% for France. Yet Walters' progress in Spain could not be happening without general economic progress; the implication being that Spain is overcoming alleged net constraints of being linked to the euro.

So unless Walters' performance in Asia Pacific and Europe is a perverse rise before these economies fall, the stock offers a means of exposure to growth sectors, also at a time of uncertainty over US corporate earnings.

Expansion continues with entry into Chile and the Czech Republic, which is encouraging in terms of global reach and to augment group profit, so long as this doesn't end up in proverbial control issues as a smaller company takes on the world. 

One-third de-rating since August

It's a rough-and-ready approach, but perception can influence behaviour: Walters' retreat from 800p to 480p in H2 2018 approximated it to the underlying trend – for what that is worth – from mid-2016, treating mid-2017 to mid-2018 as exuberance.

At about 560p, up 12p or 2% since the Q4 update, the stock trades on a 12-month forward PE of around 10 times – if earnings per share (EPS) forecasts into a mid-50p region are fair – which prices in significant risk.  Although a circa 3% dividend yield can hardly be described as a prop, unless Walters' global narrative deteriorates in 2019, then its stock is starting the year with broadly attractive risk/reward.

Admittedly, the share price has rallied 16% off its mid-December low of 480p, akin to various other cyclicals rebounding. Take care, though, as snap-back rallies can characterise a secular bear market, according to evidence from the mid-1930's, post-2000 and post-2008 market downturns.  

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What distinguishes Robert Walters is its positioning in professionals recruitment, a relatively defensive segment unless there's a serious recession, and in Asia Pacific.  Circa 20% growth rates from its key geographic regions – Q3 2018 also showed 18% for Asia Pacific and 22% for Europe – can absorb some slowdown without jeopardising overall growth.

It's possible the latest three-day round of negotiations between the US and China and Beijing does herald progress - certainly President Trump appears keen to promote this on Twitter - with both countries now motivated to prop up financial confidence. This stock may not be an outright play on such an outcome, but its Asia Pacific operations should benefit from greater stability that a US/China trade accord would represent. 

Treat 50p-plus EPS forecasts with a pinch of salt

I would still exercise care towards market forecasts lest we are looking at a cyclical peak, if only in terms of earnings growth momentum. Having achieved interim diluted EPS of 19.2p, and with the latest update asserting net fee income up 15% for the full year, personally I'd target a mid-40p area for 2018 EPS – also regarding the medium-term outlook to factor in some risk that global economic growth does ease.

The group is not significantly weighted to any half-year.  An implied prospective PE of 12 to 12.5 times is cheap in recent context, but not if US/China trade tensions do sour to undermine the global economy. The latest update cites 2018 profit to be "comfortably" in line with market expectations, though I wouldn't assume mid-50p EPS.  It's possible such numbers are a hangover from exuberance in the first half of 2018.

All-considered, I think there's a case to accumulate Robert Walters for its market positioning now that the excess has been taken out of its market valuation. I’m optimistic that the US and China are motivated to avert a US tariff hike on Chinese imports, from 10% to 25% on 1 March.  This would help de-risk cyclicals, Robert Walters being a quality example. A steady approach is wise until we receive further evidence about where the global economy is heading.  Accumulate.

*Horizontal lines on charts represent levels of previous technical support and resistance. Trendlines are marked in red.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.