Korn Ferry, Monster, Heidrick & Struggles: Recession Risk Not Priced In

Includes: HSII, KFY, MWW
by: Eric Wolff

The more I study staffing stocks tied closely to the economic cycle, the more I continue to believe that the market--despite giving lip-service to cyclical concerns, has not realized how bad things really get for these companies when the economy heads downhill. The only analyst report I found that even took a cursory look at Korn Ferry (NYSE:KFY) and Heidrick & Struggles International (NASDAQ:HSII)'s financials prior to 2003 was Credit Suisse First Boston. And is it surprising, then, that they were also the only company I could find that had conveniently not included FY09 or FY10 revenue estimates?

Nearly every analyst cites cyclical concerns in these names, but none of the ones I could find actually models a true recession scenario. Even Goldman, which has probably been the most bearish of all analysts on the permanent staffing companies, does not model anything close to a recession scenario. Let's take a look at implied revenue growth estimates for KFY:

Analysts' compounded annual growth rate estimates (Merill Lynch, Goldman Sachs, & Davenport), were derived from their latest FY09 or FY10 revenue estimates. Note that these estimates are noticeably higher than the historical CAGR (CAGR from FY01 to FY08 Q2, a full economic cycle), and much higher than the revenue CAGR KFY experienced from the peak of the last economic cycle (a -28.4% (!) CAGR from FY01 to FY03).

Though KFY has more favorable industry exposure this time around, they'll still run into some serious trouble if we head into recession. Analyst estimates aren't just off base--they are nowhere in the ballpark.

How about HSII? Analysts have been much more critical of them, and in their latest quarter they've already shown a slowdown in bookings. Also, their industry exposure (34% financial, 19% consumer) is much more exposed to areas that are likely to see significant slowdowns). Surely, estimates are more in line with past recession scenarios, right?

Once again, not even close. Even Goldman, which has a sell rating on the stock and has stated they have serious cyclical concerns for HSII, does not price in anything like a recession scenario (they call for revenues to dip in FY08, with growth resuming in FY09). Lastly, let's take a look at growth story Monster Worldwide (NASDAQ:MNST) which, many people do not realize, is actually a very cyclical stock.

Once again, all of the analysts are way above the mark. Not to pick again on Goldman, but I find it particularly funny that the analyst most seemingly concerned with cyclical issues here (Goldman), actually has the highest 2 year revenue CAGR estimate of any analyst I looked at. Even in the last recession, when MNST was a high profile growth story in North America, they saw their core MNST careers revenue drop by 12.1% annualized over 2 years.

I estimate that in a similar recession, MNST could see a 2 year revenue CAGR of -12.7%, to as high as -19% depending on assumptions. MNST's North America division, even in a more favorable economic backdrop, has struggled to grow, recording mostly single digit YoY revenue growth this year. This time around, with increased competition and a more mature market, I expect that North America will see revenue decreases in line with KFY and MNST (I model a -25% CAGR).

I assume flat growth internationally and in their ads business in a recession due to us being earlier in the maturation cycle in many of those markets. That said, if we were to go ahead and assume declines in those markets on par with what MNST experienced in the last recession (which I believe is somewhat probable, especially given the large % of international revenue from developed markets), we'd see a total revenue CAGR of -19%. If either recession scenario plays itself out, the stock would be absolutely crushed, as it was in the last recession.

What does it all mean?

Analysts and investors are forgetting how bad things get for these companies when the economy slows down. Comforted by seemingly low P/E multiples (on peak earnings), rosy management guidance, share buybacks, and other sleights of hand that will eventually be shown for what they are, I believe these three stocks will be some of the worst performing investments of the next 2-3 years (before they once again become become on of the best investments at the bottom of the cycle).

These companies will eventually post large revenue declines, huge charges, and margin compression; everyone will act surprised, despite the evidence of what happens in poor economic scenarios being right in front of them all along. If the economy does indeed head into a recession, all three stocks will suffer greatly.

Disclosure: Author is short KFY, HSII, and MNST. Author made best efforts to present data accurately, though mistakes may exist. Do your own DD. This should not be construed as advice to buy or sell shares.