Tech Staffing Companies Set to Outpace the Market

Despite some of the doom and gloom in the press, the economy is slowly recovering and investors are being rewarded for buying cyclical stocks. As such, staffing companies look like a good place to be invested. Not only is the economy helping the likes of Robert Half (NYSE: RHI  ) , but there are some secular growth trends helping, too. In particular, a technology specialist like On Assignment (NYSE: ASGN  ) is managing to grow in excess of its marketplace, and looks well placed for future growth.

Two reasons why staffing is a favorable market
First, the economy is seeing a cyclical recovery in employment. While most observers focus on payroll numbers, the American Staffing Association also issues an index of temporary and contract staffing. Fortunately, the data indicates that 2013 is set to be the best year since 2007.

  Source: American Staffing Association

Second, while increases in the staffing index have historically led to a pickup in permanent employment, there are sectors in which temporary staffing looks likely to be stronger than it has been in previous cycles. In particular, staffing companies operating in the science, technology, engineering and mathematics, or STEM, marketplace are likely to benefit from favorable trends.

For example, on its conference call, fellow IT staffing company Kforce's (NASDAQ: KFRC  ) management quoted data demonstrating that the percentage of temporary workers as a share of the labor force rose to 2.02% in the third quarter (a figure significantly "higher than last cycle's 1.96% peak").

Technology cycles are getting shorter, so corporations are more likely to hire in staffers. Additionally, according to the management of On Assignment on its conference call, companies like Accenture may be susceptible: "We're not saying that we're beating Accenture at project consulting. We're saying that the customer is deciding more often than not now that maybe they should do this on an IT staff aug basis, versus a project consulting basis."

Furthermore, if the skill sets required in STEM employment are becoming increasingly differentiated, companies will be more inclined to carry out a project by drafting temporary workers, instead of executing it internally. It takes a lot of time and money to train staff with new skills.

Staffing companies generate strong cash flows
In addition to favorable trends, staffing companies tend to convert profits into cash flow very well, and in bad times, the conversion rates tend to rise.  

Note that in the following graph, the free cash flow calculation is simply reported operating cash flow minus capital expenditures. The quoted companies may report this metric differently.


Source: Google finance, author's interpretation

On Assignment is the best pure play STEM staffing company. It competes with Kforce and the technology division of Robert Half, and all three companies look set to deliver strong performances this year.

In its latest third-quarter results, On Assignment delivered consolidated revenue growth of 15%, with Apex (a mission-critical IT staffing company acquired in May 2012) generating a 22% increase, and Oxford (a high-end IT and STEM company acquired in 2007) generating a 14% increase. Apex and Oxford made up 80% of On Assignment's revenue in the quarter, and management predicts fourth-quarter revenue growth of 12.8%-13.8%.

In comparison, Kforce's technology unit, called Tech Flex, represents around 63% of revenue, and it grew at a healthy 14.2% in its last quarter. Kforce's total company revenue is expected to grow by 12% in the quarter. Robert Half is more of an all-purpose staffing and recruitment company, and its technology segment only makes up around 12.3% of the company's total revenue. Nevertheless, recent results confirmed the trends discussed above, with Robert Half's technology revenue growing at 11.8% in the quarter, versus only 2.5% for the total company.

Kforce, On Assignment, or Robert Half?
The staffing industry is in good shape, and all three are forecasted to substantially grow earnings next year. If you are looking for international exposure across a range of industries, Robert Half's valuation of 17.9 times forward earnings should be attractive.

Foolish investors who prefer more of a STEM focus will be guided toward On Assignment, especially as it's forecast to grow earnings by 19% in 2014. The stock trades on a valuation of 22.6 times forward earnings.

Meanwhile, Kforce's growing technology segment is expected to lead the company toward $1.17 in EPS next year, putting it at 16.9 times forward earnings. All three tend to generate significant free cash flow in excess of profits, and they all look like good potential purchases for the cyclical end of your portfolio. 

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