Robert Half International: Avoid Until There Is Better Clarity On Earnings Outlook

Summary

• RHI experienced a decline in revenue by 5.6% in 1Q23, with contract staffing revenues decreasing by 8% and permanent placement revenue dropping by 15.8%.
• The outlook for RHI is challenging, with clients cutting back on staffing needs and delaying hiring decisions as the economy slows, creating revenue headwinds and lengthening sales cycles.
• The uncertain economic conditions make it difficult to underwrite the stock's risk-reward ratio.

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Thesis

Robert Half International (NYSE:RHI) operates a straightforward business, in which it provides temporary and permanent staffing services. Revenue and EPS for 1Q23 were both below the middle point of management's guidance, as was to be expected. As clients slow down their hiring and make more deliberate hiring decisions, the 2Q23 outlook was similarly dismal. RHI Talent Solutions revenue rate of decline accelerated from 4% in 4Q22 to 9% in 1Q23, negatively impacting performance in 2Q23. As a result, the slowdown in revenue growth has a negative effect on the bottom line, due to the business fixed costs. In my opinion, it is better to avoid the stock and the industry as a whole until the economy recovers. I think it is simply too hard to time the recovery, and also, RHI valuation is still has room to fall before it hits its trough (currently 14x, trough is ~12x excluding Covid period). Given the low revenue visibility and a challenging macro environment, I recommend a hold rating on RHI stock.

1Q23 Results review

RHI experienced a decline in revenue by 5.6%, with contract staffing revenues decreasing by 8.0% and permanent placement revenue dropping by 15.8%. This decline was somewhat offset by the growth of Protiviti, which saw a 4.4% increase year-over-year. I believe the current macro environment, with governments actively working to soften the labor market, has been a contributing factor to the decline. However, RHI has found some relief in its counter-cyclical segments that have provided some cushioning during this challenging period. RHI's public sector revenue has shown positive growth compared to the previous quarter, with mid-single-digit growth in both public sector Protiviti and talent solutions. The company has also managed to mitigate the weak performance in the US talent solutions market by leveraging its exposure to Europe, especially in Germany and the UK. Lastly, Protiviti's continued growth during these challenging times suggests that in favorable economic conditions, the company's performance could improve even further.

Outlook

Clients are cutting back on staffing needs and delaying hiring decisions as the economy slows, creating revenue headwinds and lengthening sales cycles, creating an increasingly difficult operating environment for RHI. No matter how you slice the results, revenue trends are deteriorating with talent solutions decline accelerating from a decline of 4% 4Q22 to 9% 1Q23. In addition, management expects revenue from talent solutions to fall by 11-16% in the second quarter of FY23. Management noted that in 1Q23, FP&A and technology faced difficulties in both staffing and operations, while admin and support functions were hit the hardest. It is also expected that these tendencies will persist into 2Q23. I expect EBITDA margins to fall further as revenue continues to decline, which RHI has limited weapons in its arsenal to cushion the decline in profits. RHI could continue to reduce FTEs, but this cannot be continuously done as the business requires labour to run. If RHI were to overcut and miss the timing of recovery, it would not be able to fully benefit from the demand, putting the business as a laggard against other better prepared peers. Another interesting thing to note is that management noted they have not seen the kind of revenue impact they would see in a recession proper. This reaffirms my belief that we are not anywhere near the trough yet, and more pain is expected to come. I am a strong believer that history repeats itself, or at least rhymes. Recession typically ends when the economy hits bottom, and employment will not recover long after that. If management words are right, it means we are still far away from the “recovery” phase.

Valuation

Consensus is expecting RHI to recover to FY22 levels (in terms of earnings) by 2025, which is kind of uncertain and hard to underwrite at the moment. We are already nearly halfway through FY23, but things appear to be far from bottoming out, if at all. I created two scenarios to demonstrate the risk-reward ratio of the stock. For the first scenario, I assume that the consensus is correct and that RHI will generate $656 million in net income in FY25. Even if multiples fell to a trough of 12x, the stock would still be fairly valued, with a 6% downside after discounting back to present value. In contrast, there is a potential 40% upside if multiples revert to the average of 17x, which is very likely as things improve. The second possibility is that the economy does not recover as quickly as the market anticipated. In this scenario, I assume that consensus figures will be one year later (current FY24E numbers will be achieved in FY25E). With the delay in recovery, I believe multiples will degrade even further to their trough. At that point, it represents a -22% loss. In comparison, the risk reward for the latter scenario is significantly lower (-22% vs 17% vs -6% vs 39%). Given the wide range of results, I recommend avoiding the stock until there is more clarity on earnings and the macroeconomic outlook.

Own model

Conclusion

RHI recent performance and outlook are concerning, with revenue declines and a challenging macro environment impacting the company's bottom line. While RHI has found some relief in its counter-cyclical segments and its exposure to Europe, the slowdown in revenue growth is expected to persist, with talent solutions revenue expected to fall by 11-16% in 2Q23. In addition, the uncertain economic conditions make it difficult to underwrite the stock's valuation, with a wide range of potential outcomes. As a result, I recommend a hold rating on RHI and suggest avoiding the stock and the industry as a whole until there is more clarity on earnings and the macroeconomic outlook.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.