Hays – After the warning the questions commence

After the warning the questions commence: Hays claims that it is business as usual, writes Andrea Felsted, but the group could yet be vulnerable to a bid:
Financial Times; Jun 14, 2001
By ANDREA FELSTED

Ronnie Frost, executive chairman of Hays, is putting a brave face on the events of the past week.

The period has seen the group issue its first-ever warning on profits, a 46 per cent fall in its share price and the resignation of John Cole as managing director.

This would be galling enough for any chairman, but it is a particular blow for Mr Frost as it comes just three weeks before he is due to retire from the company he has built over the past 30 years.

"It was not a profits warning. It was a reduction in expectation. We are still producing a profit in excess of last year," he says.

"We are still saying next year that we will continue to go back to normal growth. A profit warning is when you get told you are not going to do better than last year."

Unfortunately, the market did not see it that way. The shares fell 31 per cent last Thursday – the day the warning on profits was published – and continued sliding, to reach a low of 168p on Tuesday.

Hays said it expected pre-exceptional profits to be about 8 per cent lower than market expectations in the year to June 30 because of a downturn in the logistics division.

Analysts downgraded their forecasts of pre-tax profits from Pounds 292m-Pounds 300m to about Pounds 270m.

The key issue was not the size of the downgrade but that it had been caused by the logistics division and parts of the commercial division. These units had been seen as relatively immune from the economic cycle rather than its recruitment business, which was thought to be more vulnerable.

Hays said profits in its logistics division, which accounts for about 20 per cent of profits, would be about Pounds 10m below the Pounds 60m- Pounds 65m forecast.

It blamed the fall on lower volumes in the telecoms and inbound automotive markets. It said that as volumes had reduced, some logistics providers were fighting hard to win business, and therefore its margins had declined.

This had affected contract renewals because Hays had let a number of high margin contracts go when they came up for renewal because customers wanted to renegotiate.

Hays also faced continuing losses in its Spanish express mail division and a slowdown in its UK mail division. While volumes continued to increase, Hays said it was finding it difficult to pass on higher prices.

The profit warning also damaged the credibility of Hays' management.

Analysts said the company had been positive on the outlook at an investor conference just three weeks before the statement.

While Hays had enjoyed a stellar rating prior to the warning, the sharp fall in the share price demonstrated that investors were no longer willing to pay a premium for the Hays management.

Mr Frost will say only that the Hays board lost confidence in Mr Cole's performance over the past few months.

Analysts suggested Mr Cole, who ran the logistics division for two years before becoming managing director, was closely associated with this division, and therefore its problems.

They said Mr Cole's resignation and the announcement that Bob Lawson, due to be appointed as chairman on July 1, would become acting chief executive officer, would help to draw a line under recent events. Indeed, the shares rose 14 1/2p yesterday to 182 1/4p.

Mr Frost says there will be no further changes to management following Mr Cole's resignation, or any alteration to strategy.

"The management is perfect, the structure is perfect. The strategy is the same. There is no change," he says.

Despite Mr Frost and the market's confidence in Mr Lawson's abilities, he has his work cut out. First, the problems in the logistics division could take some time to be resolved. Because contracts tend to be long-term, lower margins could take some time to work out of the system.

In addition, although the group is talking to five parties about signing large logistics contracts, which could be worth more than Pounds 1bn each, no firm contract has come to fruition.

Second, concerns remain about the personnel division, which accounts for about 45 per cent of profits. Hays says this is continuing to grow overall, although there is some weakness in Australia and the City operations.

But a string of recent profit warnings by recruitment companies will continue to make investors nervous about this division.

Third, analysts suggest the share price fall and management changes could leave Hays vulnerable to a bid.

Geoff Allum, at Investec Henderson Crosthwaite, says Hays could be a useful addition for Deutsche Post.

"Deutsche Post is certainly trying to move into some of the areas in which Hays is the market leader."

But he says a potential purchaser would have to be "very brave" to launch a hostile bid at the moment, because, despite recent problems, the long-term story remains promising.

"The long-term strategy is still a good one. I'm not sure investors would want to let the long term go, and for this sort of price," Mr Allum says.