Temporary Staffing is Entering the "Bermuda Triangle" of Margin Pressures (Part 2 of 2)
Adem is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In part one of this series, we discussed a "Triangle" of likely economic concerns that are due to contract the margins of temporary staffing providers.
To re-cap, they are:
1). Increased volatility (good or bad) in the unemployment rate
2). Increase workers compensation rates, particularly if unemployment drops
3). Increased gas prices
To be clear, while I feel that the temporary staffing market is due for a hiccup, I don't believe it should be avoided altogether. This “Triangle” provides the largest risk to Manpower (NYSE: MAN) and TrueBlue, but competitors that operate in better geographic markets or skilled labor staffing should continue to thrive.
Stick with "skilled," stay out of Europe
Check out these numbers for the most in-demand jobs with the highest number of jobs produced, since the recession.
Nearly all of these markets are staffed by either Robert Half (NYSE: RHI) or Kelly Services (NASDAQ: KELYA); particularly Accounting for the former and Engineering for the latter. Both firms are equipped to navigate through a difficult temporary market--Robert Half because of its high margins, and Kelly because of its diversified client services. Better yet, they don’t have the exposure to Europe that Manpower has, and Kelly is expanding in the highest growth markets—Latin America and Asia.
Robert Half's brand recognition in the temporary staffing industry is so strong that some of its brands are synonymous with the markets they serve (i.e., Accountemps). This creates credibility amongst clients in fields that need experts and drives Robert Half's ridiculously high billing rates. Robert Half has a respectable operating margin of 9%, but it'd be much higher if you subtracted the cash they spend to have some of the best recruiters in the industry--most of whom are former accountants, lawyers, etc. These are expenses that firms like Manpower and TrueBlue largely don’t have, but it’s also what drives gross margins higher.
The typical bill rate for Accountemps, for instance, is a 60% mark-up. That means, if Robert Half pays an employee $10 per hour, they bill their client $16; a remarkable feat. So remarkable, that it leads Robert Half to have gross margins nearly three times as fat (41%) as the aforementioned Manpower. This fact, coupled with the fact that Robert Half’s white collar staffing model comes with essentially no workers compensation risk, makes up for the fact that they're primarily a temporary staffing provider.
In other words: high margins + brand moat + lower risk=a good place to start!
PEO providers offer flexibility in down markets
While Robert Half has been on an absolute tear, I believe misinformation has lead Kelly to still be a bargain. Sure, the stock has risen to a 52 week high, but it’s within a much tighter range, and still far off its pre-recession price (around $35) despite being more profitable today.
Kelly’s earnings are projected to rise 14% this year, and considering that it has met or exceeded earnings for 12 straight quarters, I feel comfortable building a position based on those projections. Kelly has a strong long-term temp business in growing skilled labor areas like Engineering, but also offers much more. The company is successfully transitioning its business to have more exposure to permanent placement and especially HR outsourcing, PEO and Vendor Managed Services (VMS,) all of which have low overhead and risks. Those services also thrive in all “economies,” good or bad, because they save companies money.
Kelly's transition, and the market's impression of it as a solely "temp" business, resembles Barrett Business Services (NASDAQ: BBSI) two years ago. The difference, of course, is that Kelly offers its services (aside from VMS) solely coupled with its staffing services, like Manpower, but Kelly is in stronger disciplines and markets.
But if you want the strongest PEO/HR outsourcing play, it’s Barrett that has cornered the market on offering all-in-one HR business services to clients: workers compensation, staff management, staffing/recruiting, and much more. For years, this stock has been a favorite of mine as the market misunderstood it as a "temp stock," which is so, so wrong. Alas, Mr. Market has come to his senses and the stock has soared over the past 12 months, from about $17 per share to $46!
There's still plenty of room to run--even today Barrett has a PEG of just .56. I think the market has Barrett right this time, and the company should keep growing because it offers its clients a truly unique service. In one fell swoop, Barrett can come in and essentially outsource an organization's entire HR, hiring, and (largely) payroll functions. This provides incredible cost savings, flexibility and risk aversion. Simply put, Barrett becomes more valuable as the market becomes less stable.
Kelly, Barrett or Robert Half could all make outstanding plays for different reasons. Barrett offers staffing and outsourced management services, Robert Half specializes in finding very skilled labor, and Kelly gives you a little bit of both. Which is the right pick for you depends solely on your investment objectives and personal preferences.
The brighter side of the "triangle"
The market for temporary staffing is about to enter a transition; that's just the cyclical nature of this business. But the long-term prospects for top providers is still very bright. The easy money, largely, has been made. It's unlikely that all of the industry will continue at the torrid pace of recent years. It’s become a stock pickers game, and picking these company will help you navigate through the Bermuda Triangle.
mrrightside has no position in any stocks mentioned. The Motley Fool recommends Robert Half International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!