The U.S. Bureau of Labor Statistics reported a significant slowdown in employment growth in the month of May 2012. Payrolls increased modestly by 69,000, following similarly tepid payroll growth in the previous month. In comparison, the average monthly gain was 226,000 in the first quarter of the year.
The unemployment rate continues to hover stubbornly around the historically elevated level of 8.2%. Since the end of the most recent recession, employment growth has been sub-par relative to jobs growth following most previous recessions. Now, the likelihood of a notable slowdown in U.S. economic activity threatens to derail the slow jobs recovery.
While most economic sectors are affected by the changes in the labor market, including the consumer and home-building sectors, some industries are disproportionately impacted by the labor market developments. For instance, companies engaged in payroll processing and related services record higher revenues when payrolls rise and vice versa.
The labor market conditions also have an overarching influence on the health of staffing agencies. These agencies' business fully depends on employment opportunities across industries and markets. A renewed reluctance of U.S. businesses to hire will adversely affect the market prospects of these companies. Moreover, as benefits outsourcing firms earn interest from their client's money, declining interest rates in a weak economy adversely affect overall revenues.
Here is a look at four companies in the employment services industry that will face challenges in case the U.S. jobs recovery falters. Some of these companies boast attractive dividend yields; however, their stocks are currently less attractive for investment than some other high-quality alternatives with equally generous dividend yields.
Paychex Inc. (PAYX) is a $11 billion payroll, human resource, and benefits outsourcing company serving more than half-a-million businesses in the United States and a small number of clients in Germany. It has total annual revenues of $2 billion. When unemployment rises, demand for Paychex's services drops and its revenue declines due to a decrease in the number of payroll checks processed per client.
The opposite occurs when employment grows steadily. Assuming that the jobs rebound continues into the future, analysts have forecast that the company will grow its EPS by 10.4% a year for the next five years. This rate of growth is likely exaggerated, given that it is three times higher than that realized over the past five years when employment contracted during a recession and struggled afterwards.
Paychex's stock pays an attractive dividend yield of 4.2% on a high payout of 85%. Interestingly, during the 2008-2009 downturn, the company had raised dividends in 2009, but kept them unchanged through 2011. The company's dividend has hardly increased over the past three years. As regards valuation, Paychex's P/E based on trailing-twelve-month earnings is on par with the industry metric. It also trades well above the P/E of the broad market.
A recent article in Barron's featured research from Morningstar that concluded that "Paychex's dividend yield is attractive." While its dividend is certainly high, it is comparatively less attractive than the high-yield on a number of dividend-paying companies in less cyclical sectors. It should be noted that among fund managers, Joel Greenblatt and Richard Perry (Perry Capital) bought minor stakes in the company in the first quarter of 2012.
Automatic Data Processing (ADP) is a payroll processing and outsourcing services company. The company has a market capitalization of $26 billion and total annual revenues of almost $10 billion. Rising unemployment affects the company's business the same way it affects Paychex's. Assuming that hiring will be fairly strong in the future, analysts expect the company to boost its EPS by 9.6% a year for the next five years. It is interesting that ADP processes almost 5 times more W-2 forms than Paychex, but has net income only twice that of Paychex.
The outsourcing company pays a dividend yield of 3.0% on a payout ratio of 57%. The company has grown its dividend by an average rate of 24.2% a year over the past five years. Even during the last downturn, the company was able to boost its dividend payouts. In fact, the company is a dividend aristocrat because it has increased dividends for at least 25 years in a row.
As regards its valuation, the company's stock trades on a P/E slightly below the industry ratio, but well above the ratio of the broader market. The stock is popular with fund manager Jean-Marie Eveillard (First Eagle Investment Management - see top picks), who has a 0.7% stake in the company.
Another company that fares poorly when hiring subsides is staffing and workforce solution services company ManpowerGroup (MAN). This second largest staffing company in the world has a market capitalization of nearly $3 billion and total revenues of $22 billion. Two-thirds of the company's revenues come from low-skilled labor placement.
Moreover, as 50% of the company's revenues come from Europe, ManpowerGroup's problems are exacerbated in the current economic environment. Analysts estimate that the company will grow its EPS by almost 14% a year for the next five years. The forecast is based on an assumption that hiring will flourish in the future, which is unlikely. In fact, this vibrant forecast growth compares to a drop in EPS of 2.7% a year over the past five years.
The company pays a dividend yield of 2.5% on a payout ratio of 28%. It froze its dividend in the 2008-2010 period and recently increased it only modestly. Regarding its valuation, the company is fairly undervalued relative to its peers and the broader market represented by the S&P 500 index. The stock is out of favor among fund managers, as Joel Greenblatt sold out of his stake in the first quarter of 2012 and Ray Dalio significantly reduced his small position.
Robert Half International (RHI) is another staffing and jobs outsourcing company. It has a market capitalization of nearly $4 billion and total annual revenues of $3.8 billion. Analysts estimate that the company's EPS will expand at an impressive 17.4% rate per year for the next five years. Again, this forecast assumes that the U.S. labor market will be growing at a robust pace. The growth seems to be overly optimistic, given that the company was cutting its EPS at a rate of 8.5% a year over the past five years.
The staffing company pays a dividend yield of 2.2% on a payout ratio of 50%. The company has increased dividends by 10% a year over the past five years. Despite the decline in revenues during the most recent recession, Robert Half International was able to increase its dividend payouts. The company is currently overvalued based on the trailing-twelve-month P/E. Chuck Royce cut his stake in the company by 5% during the first quarter, but billionaire Jeff Vinik quadrupled his stake to $58 million.