Stockwatch: is it ‘darkest before dawn’ for this cyclical share?

In my last piece on advertiser WPP (LSE:WPP), I mentioned how major recruiters such as Hays (LSE:HAS) and PageGroup (LSE:PAGE) had similarly experienced a downturn in the second quarter of 2025, and that we should pay more attention to these cyclical companies rather than markets hitting new highs.

• Our Services: SIPP Account | Stocks & Shares ISA | See all Investment Accounts

Subsequently, last Tuesday, the small-cap recruiter Robert Walters (LSE:RWA) issued a grim update with net fee income (NFI, the performance benchmark for agency-type businesses) down 13% like-for-like in the second quarter and by 14% for the first half.

Although NFI was actually higher than the first quarter due to seasonality, “macroeconomic uncertainty became more pronounced”, it said, with new job flows and interviews slightly weaker versus the end of the first quarter.

While the UK represents a modest 18% of NFI, and Walters is focused on hiring professionals, the update affirms the Office for National Statistics (ONS) yesterday citing UK unemployment up a slight 0.1% to 4.7% in the three months to May. It edges up stagflation risk after UK inflation rose to 3.6% in June, well above target.

A remarkable share price drop

I have followed Walters periodically since it floated in late 1996, and this latest volatility is greater than around the 2008 financial crisis and subsequent recession. Covid was a disruptor but after a mid-2018 high around 750p and plunge near 300p in March 2020, market price soared to over 820p by early 2022 – now down to 168p.

We saw a similar dynamic in WPP up to early 2022, then an extended bear market, so might this reflect over-pessimism currently, just as the early 2022 highs proved too hopeful?

Source: TradingView. Past performance is not a guide to future performance.

A reversal in net profit from £39 million in 2022 to a £6 million loss last year, and with consensus (so far) suggesting a loss above £10 million, this year understandably looks stark. A £24 million profit is pencilled in for 2026, although I would treat that as notional given very low visibility in this industry. It implies a forward price/earnings (PE) ratio around 29x, although that would come down with a longer-term profit rebound.

Margins and return on capital have been erased, reflecting how difficult the challenge to manage recruitment groups is - to what extent should they cut back service when demand falls, or maintain capability to exploit any recovery? 

Headcount eased 2% to 3,125 over the second quarter of 2025 albeit down 14% on June 2024, within which non-fee earners were flat quarter-on-quarter at 1,310 or down 10% year-on-year, as if a certain support staff level is necessary for the business to function.

• Why FTSE 100 stock Diploma was just chased to record high
• ii view: Hays shares crash to lowest since financial crisis – here’s why

Walters exited the first half of 2025 with a monthly operating cost base of £24.5 million, only down from around £25 million at end-2024. Despite the 15 July update citing “further cost reduction planned for the second half”, it suggests management has been wary about cutting the business further, although it is now forced to do so. Say £23 million monthly costs are achieved, it implies nearly £140 million over six months – close to the £140 million NFI achieved in first-half 2025.

The downturn across listed recruiters since the pandemic begs questions about whether clients have become more self-sufficient at hiring, employees are now cautious at switching jobs, and also if AI automation is becoming an investment priority within businesses over people.

Robert Walters - financial summary
Year-end 31 Dec

Source: historic company REFS and company accounts.

Might very low valuation vs net fee income invite a bid?

This I find intriguing. Walters’ market capitalisation of £122 million is less than 0.4x 2024 NFI. In corporate analysis, 0.4x sales alone might be assumed a material undervaluation pending long-term recovery, but here it is gross profit. By comparison, PageGroup is just below 1.1x and Hays just shy of 1.0.

Possibly with Walters it reflects permanent hiring accounting for 66% of NFI, which tends to get hit harder than temporary in a downturn. Yet PageGroup has an approximate 70:30 split between permanent and temporary, while Hays is the reverse: temporary and contracting have recently risen from 59% to 62%. Income split does not satisfactorily explain the market cap/NFI ratio but certainly is relevant to business risk.

Illiquidity among small-caps is another factor.: Walters is liable to be more volatile both ways, down 80% from its early 2022 high, whereas PageGroup has fallen 55% and Hays 53%.

If Walters’ ratio is at all likely to mean-revert in the longer run, the shares should re-rate and it also invites a takeover. Not only is it looking timely to go private, eliminating listing costs, there must be scope to take out far more of Walters’ operating cost base if integrated within a larger group.

Total dividend looks unsustainable

Paid since 2022, the dividend looks like an inevitable casualty given the business could be unprofitable at least for the second half of 2025.

The 15 July update cited £30 million cash at end-June, down from £42 million at end-March due to payment of a 2024 final dividend. A 23p total dividend per share would cost £17.0 million at the latest 72.358 million shares issued, versus £15.5 million cited in the 2024 cash flow statement, which may reflect timing issues given it represents a 12-month period.

• Here’s where professional investors are piling in
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis

A 6.5p per share interim payout could thus easily be paid at a cost of £4.7 million, leaving the decision as to the extent of final dividend until February 2026. I think this is likely when the board announces interims on 31 July, as omitting the interim would imply dire prospects. None of the three recruiters I mention is engaging in share buybacks, which does, however, say something about boards’ wariness over cash flow.

While a circa 12p total dividend also looks payable and implies a 7% yield on a 168p share price, if the company is unprofitable early next year, then the market may not regard even this as sustainable.

Positives if interest rates cut

Unless corporate profit warnings multiply, the stock market could attune to rate cut prospects both in the US and UK, where Federal Reserve governor Jerome Powell is under pressure to do so, and the Bank of England governor is reportedly willing to look through the latest UK inflation figure to a weaker jobs market tempering this. Europe is an open question on monetary policy, where Walters derives 30% of NFI and which fell the most - 22% - in the first half.

But if rate cut hopes gain traction, there could well be some speculative pricing-in of recovery potential in hard-hit cyclicals. There is a scenario where 2026 does at least see Walters back into profitability, in which case, now is “darkest before dawn”.

If anyone has considered taking this company over – whether management to further cut costs, or a larger group to exact synergies – then now is the time to pitch.

Recommending any offer terms would, however, be very hard given the high uncertainty with projections. Median net profit could be anywhere from £10 million to £30 million, implying a PE around 12x to 4x at the current share price. Net gearing may only be around 20%, however, so debt is not stretched.

I last wrote on Walters exactly two years ago having cautioned in January 2023 how recruitment sector warnings of tougher market conditions were an interesting straw in the wind. At 420p, I was averse to “buy” but concluded, “a case therefore exists to hold if you already do, with a view to add if economies turn grisly”.

Hence the imminent 31 July update being a crux on whether the latest downturn has continued. It would be undisciplined of me to suggest “buy”, so I have to stay with “hold”. However, the shares could rise simply if the story has not worsened.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.