Robert Half: May Be Too Soon To Buy

Summary

• RHI has pulled back almost 40% from all-time highs, likely in anticipation of a cyclical downturn in hiring.
• The company has a strong balance sheet with no debt, has consistently raised the dividend since 2004, and continues to buy back shares at heavy clips.
• Caution is still warranted though as the company is highly cyclical, and after the 2008 financial crisis, revenues did not recover back to 2008 levels until 2014.
• Using conservative DCF estimates, I estimated the company is worth approximately $7.3 billion, indicating shares still trade at a slight premium to intrinsic value.

SunnyVMD

Executive Thesis and Overview:

Value investors might be drawn to Robert Half International (NYSE:RHI) as it has a rock-solid balance sheet with no debt, high returns on capital, and shareholder friendly policy with most of its free cash flow shoveled into dividends and share repurchases. Indeed, RHI initially came up on one of my value screens for low EV/EBITDA companies, with its lack of debt and recent good performance clocking in the trailing metric at about 7.5. Combining this with a nearly 40% drop in share price recently had me itching to take a long position.

The question I should ask myself before the knee jerk contrarian in me buys, is why is it trading this way? The answer in this case is likely the cyclical nature of the business. Robert Half operates primarily in the US and obtains about 62% of its revenues with contract talent solutions, 10% with permanent placement, and 28% with Protiviti, its business consulting firm. All are cyclical macroeconomically, with the core business benefiting recently from the tight labor market.

If the economy turns and the labor market flips, RHI's cash flow will likely be impacted immensely. I would like to explore if the current stock price offers a large enough discount to account for this. So far, there has not been a significant uptick in unemployment despite the federal reserve's best efforts, with the metric reporting in at 3.5% as of March 2023.

Is Now a Good Time to Buy?

With RHI stock declining almost 40% from a year ago, the question is raised if any future revenue losses are already priced in. Going on the idea that this company performance is negatively correlated with unemployment rate, I wanted to use history as our guide and look back at what happened in 2008.

BLS via Data Commons

As we can see from the graph, though unemployment began rising slowly starting as early as 2007, it really started to ramp up in April 2008 and peaked at 10% in Oct 2009. We know this likely impacted Robert Half's revenue and earnings, but what happened to the share price? Let's take a look:

TradingView

The first blue mark on the graph notes when unemployment rate started to rise, while the second marks when it peaks. Clearly, waiting until we see a peak in unemployment is too late, at least in this example. It should be noted though, that the declines and bottoming in March 2009 is closely correlated with the declines in the S&P 500. This particular drop therefore may have less to do with intelligent analysis, and more to do with indiscriminate selling.

After this time period though, the stock trades volatilely and bottoms again in 2011 at $20 before having any sustained growth in share price, being outperformed by the S&P 500. The protracted high unemployment likely had a lasting effect on RHI's business performance as well, with revenue not recovering until 2014. Judging by historic data, buying shares now may expose the investor to more downside risk if and when unemployment actually begins ticking up and it becomes more difficult for the company to make placements.

The Dividend Policy

It's worth noting that the company has managed to increase its dividends by about 12% CAGR since 2013 and increased the dividend even in the 2008-2011 period. At current market quotations, it yields about 2.5%, which is not very high, but it's combined with massive stock buybacks. I don't necessarily consider the dividend to be a good thing, and I'll explain why.

If the company again has post-2008 like results, the stock will likely again become undervalued relative to intrinsic value. The stock can also be overvalued during boom cycles. The policy of consistent dividend hikes will theoretically skew proportional free cash flow to dividends when the company is not performing well and the stock price is low, and to buybacks when the company is performing well, and the stock is more expensive. What appears best on the surface (a steady increasing dividend) may not be what is best for long term shareholders even if it is generally accepted good practice.

Valuation:

I took a conservative approach to my modeling, and assumed the swing of the economic cycle would bring similar struggles to the company as it did in 2008, with free cash flow getting cut in half this year and further reductions in 2024. After this, the company would slowly recover into 2030, and due to its superior branding, shareholder friendly nature and demonstrated growth cycle to cycle I assumed a 4% terminal growth rate on track with global GDP. I used a 10% discount rate as the company has no long-term debt, and as this is likely the minimal rate of return investors would expect. This gives us a terminal value of $7.3 billion, and is demonstrated as follows:

RHI DCF (This Writer)

Inverting the Thesis:

This Time Could be Different

People have been anticipating a recession for a long time now, but we are still yet to see a significant increase in the US unemployment rate. The fed may achieve a desirable "soft landing" and employment could stay relatively high. Additionally, comparing the rapid rise in unemployment related to the 2008 banking crisis may be misleading, as there is no obvious similar crisis unfolding at this time.

The Business is Different Than it Was

In 2008, revenue from Protiviti, the company's business consulting segment, was $547 million or 12% of total revenues. Now, Protiviti makes up approximately 28% of the revenue mix. Having a more diversified mix of revenue could ease out some volatility, but consulting is also a cyclical business.

Use of AI

Over the last 7 years the company has been working on AI technology to assist with the job matching and search process, which could help reduce SG&A expenses in any prolonged downturn. The flipside is as this technology gets more advanced and easier to implement, there may be more competition for RHI's market share.

Increased Use of Contract Work

Forbes has written that in order to cut costs, companies are hiring more contract labor. This could be a boon to RHI, as 60% of revenues come from contract worker placement. In spite of this, RHI has demonstrated in previous cycles that any macroeconomic weakness hurts earnings immensely.

Strong Balance Sheet

The company has a strong balance sheet, with $1.5 billion in stockholder's equity, $1 billion in net current assets, and no long-term debt. This deserves a premium over the PV of future cash flows, as the company will likely continue to pay shareholders with dividends and buybacks despite reduced cash flow during cycle lows. The company has also demonstrated its ability to remain free cash flow positive in down cycles.

Conclusion:

On first glance, this is a high-quality business with no debt, high returns on invested capital, and a shareholder friendly policy with massive buybacks and dividends. I want to own more of the company but am hesitant as RHI has benefitted from the tight labor market, and if 2008-2011 is any indicator of what could happen if employment falters shareholders are in for a negative to flat couple of years. Our models indicate the company trades at a premium to its intrinsic value of $7.3 billion, with the assumption that 2022 is the end of a cyclical growth phase. Part of the premium paid could likely be for the strong balance sheet, which might justify the current share price.

It seems that a bet on RHI is a bet on a strong economy and labor market, which currently seems uncertain. Caution is warranted, though I do think this is a great, shareholder friendly business. Volatility in the end is a provider of opportunity, and we may have greater opportunity even after a nearly 40% drop from all-time highs. I have about 1/4 of the position I want and will likely add more if conditions worsen.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of RHI either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.