According to the efficient market hypothesis (EMH), all available information is already reflected in share prices. Thus investors shouldn’t bother with stock picking — because alpha is too arbitrary or requires excessive risk — and embrace a nicely diversified passive index instead.
As a rebuttal of EMH and a good case study of market behaviour, there’s Adcorp Holdings, a JSE-listed small-cap staffing business.
At the start of 2015, South Africa’s Labour Relations Amendment Act of 2014 came into effect. It stipulated, among other things, that employees assigned to a client by a labour broker (a pejorative in some circles for “flexible staffing provider”) for more than three months are deemed to be the permanent employees of the client (though it would take another three years and a Constitutional Court ruling to confirm that the client company becomes the sole employer).
The potential impact of the law, which was first promulgated in December 2013, on staffing companies such as Adcorp seemed obvious. Yet Adcorp’s share price was blissfully unaware of the impending doom, trading at post-global financial crisis highs of about R34 until July 2015. Then, for over two years, as results started to reflect reality and numerous clients took on contract staff as permanent employees or simply terminated their employment, the share price plunged by two-thirds. It bottomed out at about R10 in June 2017.
To be fair, there were compounding factors — such as overpayment for acquisitions, excessive management layers, poor working capital management, stresses in certain sectors such as African oil, and training losses. But growth in the company’s core business could have offset these challenges to a degree — or perhaps negated the need for more risk-taking in the first place.
The share price had a brief recovery when highly rated investment firm Value Capital Partners took a stake and installed new management, but the price crashed back to R10 after the aforementioned Constitutional Court ruling in 2018. A weak economy and the impact of Covid smashed it down further to just 200c.
Today, the share trades at about 500c. Though these are far from the company’s glory days, progress has been made on several fronts. This includes geographic diversification into Australia (now 50% of profits), the establishment of a cost-efficient centralised back office function (payroll, debtors, creditors, treasury) and maintaining a healthy balance sheet with no debt. While there’s still reputational risk and political noise with regard to labour brokers, the worst is probably behind it … and in other parts of the world, labour broking is actually gaining ground.
With an almost 50-year history, 37 years as a listed entity, Adcorp has other advantages. As the biggest listed staffing company in Africa, it has the scale to cope with small industry margins and onerous working capital requirements (most notably paying expenses upfront while getting squeezed by clients on payments terms).
As the biggest listed staffing company in Africa, Adcorp has the scale to cope with small industry margins and onerous working capital requirements
Comprising 33 specialised brands including Blu, Kelly and Paracon, Adcorp has also diversified across different industries and job types (from IT specialists to factory floor workers), with many clients having bona fide needs for temporary or contract workers in compliance with labour laws (such as seasonal workers in retail and hospitality or IT engineers for project work).
Though temporary and contract staffing forms the major part of the total business at 55% of earnings before interest, tax, depreciation and amortisation, it isn’t the company’s sole source of income. High-margin permanent placements — while currently depressed due to tough macro conditions — deliver about 35% of profits, while functional outsourcing makes up about 10%.
The two labour markets in which Adcorp operates couldn’t be more different. The Australian subsidiary is weighted towards white-collar technology jobs — where competition for talent is always fierce — but even its smaller blue-collar business faces a shortage of workers (forcing the company to import foreigners on four-year visas). While South Africa’s white-collar division struggles with the same constraints, the much larger blue-collar business has access to a vast pool of low-skilled workers for jobs in mining, manufacturing, retail and hospitality.
From a broader economic perspective, though, there are similarities. Both countries are resource rich and subject to commodity cycles, while variable-rate mortgage loans make consumer disposable incomes particularly sensitive to interest rate movements. Cyclically, therefore, both countries are poised for better days.
Adjusting for a one-off tax gain, Adcorp trades on a trailing earnings multiple of 7.5 — but this is only 3.5 if net cash of R275m is considered. The share also offers a juicy dividend yield of 8%. Furthermore, Adcorp is looking to sell noncore and subscale operations (most brands are independent and self-sufficient) and to return capital to shareholders, or, alternatively, make bolt-on acquisitions to enhance scale. Adcorp is also keen to expand in the rest of Africa (for example to the Mozambique gas industry).
Given the company’s scale, industry diversification and cheap valuation, Adcorp is probably not the worst way to position for a recovery story in South Africa and Australia, especially as employment is normally closely correlated to economic growth.
Of course, if the EMH takes your fancy, you can ignore 3.5 earnings multiples companies on cyclical lows and just buy an index. But, besides many scholars deriding it as an academic fantasy devoid of merit, where’s the fun in that?
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