Five Picks for a Dour Employment Market
These employment-related stocks have the strength to withstand a turbulent job market.
"Help Wanted" signs have been a rare sight over the past year. Most businesses have lowered their employee headcount over the last 12 months due to the current recession. Unfortunately, this trend will continue affecting most sectors of the economy and this is especially true for firms that provide employment-related services. Thus, understanding how high the unemployment rate could climb is key to forecasting what could happen to the employment-related firms in our coverage universe. Obviously the situation is dynamic, and things may improve or worsen at any moment. In this article, we will provide our analysis and our conclusions as to where the rate could possibly go. We will examine how certain data points have behaved in the past, and we'll try to determine where those datapoints are telling us things may be headed. We will also point out firms that we believe offer great value for investors and others that may not.
The Rise of Unemployment
Watching the employment market over the last year has been as painful as watching former Illinois Governor Rod Blagojevich publicly defend himself against corruption charges. The unemployment rate has moved up 260 basis points to 7.6% as of January 2009 from 5.0% as of January 2008. The catalysts for this movement came in two stages. First, the real estate bubble burst, and this caused year-over-year job losses related to the construction market to climb. The unemployment rate for this sector has risen to 18.2% as of January 2009 from 11.0% a year earlier. Second, falling real estate values and the growth in foreclosures precipitated the troubles in the financial sector, which led to a freezing in the credit markets. The lack of credit placed a premium on firms having a strong balance sheet. Coupling this factor with a fierce recession induced many firms to cut costs through reduced headcount. The aggregate effect leaves the employment market where it is now.
What Are the Data Suggesting?
There has been much discussion about the severity of unemployment. Although we are not going to give a specific estimate of where unemployment will end up, we will provide some data we are looking at from the Bureau of Labor Statistics, what these data suggest in our opinion, and how this information will affect some of the employment-related firms we cover.
Temporary employment is typically seen as a leading indicator for the aggregate employment market. Companies tend to divest their temporary workforce before they start to cut into their permanent staff, because temporary workers are less costly to remove. They act like a buffer where firms can lessen their headcount without the adverse effects of permanent staff layoffs. Thus, movement within this employment segment can signal what businesses believe their staffing needs may be in the future. Of particular interest is the pace at which firms are adding or subtracting from their temporary labor staff. The pace of a downward or upward trend can signal the possible momentum of total job losses or creation over the near term and the long term. The graph below shows the monthly sequential percentage change in temporary employment beginning six months before the official start of the last three recessions until the end of the recession (with the current recession still in progress).
The data clearly show that the current pace of job loss for temporary workers has been accelerating throughout all of 2008 (months 1 to 12) and this trend may not see any significant improvement through a good portion of 2009. The prior two recessions both lasted approximately nine months while the current recession has lasted about a year and is anticipated to continue for some time. As illustrated, temporary employment for the current recession has been falling at a much faster pace and for a longer period of time than in the last two recessions. The confluence of a longer recessionary period with a more vitriolic pace of temporary job losses does not bode well for our current situation and could lead to a higher peak unemployment rate.
The relationship between the monthly sequential percentage change in temporary employment and a corresponding change in the unemployment rate is somewhat lagging and divergent. This is best demonstrated by looking at the movement of both metrics over the last 12 years shown in the graph below.
As shown in the above graph, after temporary employment headed down before the last recession (arrow 1), the unemployment rate went up (arrow 2). Accordingly after the utilization of temporary labor went up (arrow 3) during and after the last recession, the unemployment rate trended down (arrow 4). From the data, there is somewhat of a lag between when the inflection points are reached for each statistic. However, the behavior of this relationship during the current recession is quite different and very troubling. First, the degree of the downward movement in temporary employment (arrow 5) is greater than the last recession. Second, there is very little lag between the downward movement of temporary labor utilization and the increase in the unemployment rate (arrow 6). This likely signals that businesses are so concerned about the current economic environment they are disposing of more workers than just their temporary staff. By the time temporary employment utilization bottoms out, the unemployment rate may reach the 8%-9% range. There is also usually a time of a continued upward trend for unemployment after the monthly sequential percentage change in temporary employment bottoms, and if this trend holds it would push the unemployment rate even higher.
The second dynamic we want to explore is the direct inverse relationship between the unemployment rate and the trend of non-farm job growth/retrenchment. The number of non-farm jobs within the United States is estimated by the Bureau of Labor Statistics on a monthly basis. The Bureau takes a survey of payrolls from a variety of firms in every sector of the U.S. economy and estimates the current total number of non-farm jobs throughout the country. There is an obvious relationship between the increase or decrease in non-farm jobs and the unemployment rate. The current trend for both data points is very worrisome.
As can be seen from the graph above, the three-month moving average for the change in non-farm jobs is currently at a downward level not seen since the end of the first of two recessions back in the early 1980s. However, the current unemployment rate is at 7.6%, which is 20 basis points below the level it was at that time (7.8%). The 1980s unemployment rate did increase 300 basis points over the course of the second recession a year later, which pushed the rate to 10.8%. Granted the early 1980s' recessionary period was "W" shaped, but the current recession is expected to last well into 2009 with a possibility that it may last into 2010. This would put its duration very close to the combined timeframe of both 1980s recessions. To put things into perspective, adding the 300-basis-point movement experienced after non-farm payrolls bottomed during the 1980s timeframe to the current unemployment rate of 7.6% would bring it to 10.6%. Now, every business cycle is different and the current economic factors are not the same as the ones formulated during the 1980s. However, if we experience a rise in employment that is only half of what was experienced when payrolls bottomed in the 1980s, the unemployment rate would be close to 9%.
Even factoring out the early 1980s "W" shaped recession, the unemployment rate usually rises a material amount after the losses in non-farm jobs reach apex. Given that the sequential three-month moving average for the change in non-farm jobs usually does not bottom until the end of a recession, it may be well into 2010 until the current unemployment rate peaks.
Given this, there is a good possibility that the unemployment rate will flirt with high-single-digit to low-double-digit levels by the end of the current cycle. Other mitigating factors may come into play such as the effect of the stimulus package currently being debated in Congress. Nonetheless, an unemployment rate that could reach a level not seen for over three decades is a very unnerving scenario due to the implications this would have upon the entire economy.
How This Affects Our Forecasts for Our Employment-Related Stocks
Of all of the companies in our coverage universe, staffing firms are some of the most heavily reliant upon the state of the employment market for obvious reasons. In addition to the head winds faced by all staffing firms, we would like to highlight a heightened concern for firms that specialize in financial industry staffing. Staffers who provide workers for this sector tend to generate greater operating margin than their peers due to the type of workers and projects that are involved. The dramatic fall in employment demand for financial services, however, will no doubt affect the financial staffing firms greatly. One of the strongest staffers providing financial related workers, Robert Half (RHI), recently reported earnings results that were lackluster at best. Other firms that provide such workers, but which have weaker staffing networks, have and should continue to suffer to a larger degree than Robert Half in our opinion. Firms such as Kforce (KFRC) and Hudson Highland Group (HHGP) will face strong head winds over the near term due to the major falloff in employment metrics for the financial-related labor market.
There are a few stocks in the employment realm that we believe offer good investment value even with the severity of unemployment and the great uncertainty permeating throughout the labor markets. Most of these stocks offer various kinds of employment-related services that provide good competitive advantages.
1. We strongly believe Automatic Data Processing (ADP) and Paychex (PAYX) have the wherewithal to withstand the strongest of labor market head winds. Even if the unemployment market takes a dramatic turn further downward, businesses still need to pay their existing employees. The high customer switching costs and business model scalability for both ADP and Paychex should help the firms preserve revenues and profits. These firms have consistently produced strong operating margins and great returns on invested capital over extended periods of time. These stocks trade in 5-star territory even with a downturn factored into our fair value estimates.
2. There are very few staffers we would recommend at this time. Staffing firms are extremely cyclical and the poor fundamentals of the staffing market are challenging for every player. Strong staffing networks are the key to success, and two firms we would watch are Resources Global Professionals (RECN) and AMN Healthcare (AHS). We believe the niche markets in which these firms currently compete are great for their long-term prospects. However, they do face extremely fierce near-term head winds, and any investment within these businesses should be made with a long-term investment horizon.
3. The last firm we would like to highlight is Cintas Corporation (CTAS). This firm mainly provides uniform rental services to businesses across North America. Cintas' proven ability to leverage its business model has served it well over the years. However, the firm's most recent earnings rustles were disappointing and management pulled its full-year guidance. Given its troubles over the last year, Cintas' stock price has plummeted 27% and we believe this has created a significant opportunity. Even with the near-term head winds, we still believe Cintas will be able to offer great value over the long run due to its strong competitive position.
Caution should be used when considering an investment within any of these firms due to the turbulence of the near-term labor market. However, we have factored several recessionary scenarios and their effect upon the employment markets into our forecast for each of these firms. Even though things may be bleak and could get a whole lot worse, employment-related services will always be needed as long as businesses employ workers. Finding the firms that can withstand the most dire of scenarios is the hard part, but we strongly believe the picks we outlined above offer the greatest potential for long-term value creation within our employment-related coverage universe.
Vishnu Lekraj does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.