Paul Hill, share tips

Turkey of the week: consultancy business model will come unstuck

11.04.2008

by Paul Hill

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During the early 1990s many sectors were badly mauled in the protracted recession. Among the worst affected were consultants, whose business models came unstuck as companies reined in spending. I would not be surprised to hear that finance directors, faced with fees often in excess of £1,000 a day, were once again freezing budgets and blocking the use of external advisers. The impact of any slump is likely to be most keenly felt by consultants operating in cyclical industries such as property, banking, advertising and recruitment. But if the downturn proves as desperate as the one we saw in the 1990s, even the most resilient parts of the consultancy market will be knocked.

RPS Group (RPS), tipped as a BUY by WH Ireland

Take RPS Group. It is Europe’s largest environmental consultancy, specialising in the development of natural/energy resources (33% of fee income), land and property (44%), and the management of the environment (23%). Over the past two to three years it has been a darling of the FTSE 250, with its shares doubling from 150p over that period. The business has capitalised on the boom in energy markets, the introduction of new, green legislation, growth in urban regeneration and the upgrade of water and transport infrastructure.

Its preliminary results in March showed that organic growth was an impressive 14%. Chairman Brook Land said that “2007 was another very successful year”, and he expects “another good result in 2008”. Clearly business is holding up well in the face of tougher conditions.

However, as the year progresses I can see its crucial Government and corporate clients – especially in the more cyclical land and property unit – pulling in their horns and reining back on discretionary items.

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So I think there’s a real risk that RPS Group’s reputation with the City as a relatively recession-proof stock could rapidly unwind, leading to the loss of its premium valuation. Any correction could be quite sharp, as the shares trade on punchy multiples of 17 and 15 times earnings for this year and next, yet only pay a skinny dividend yield of 1.1%. I would value the company on a 2008 p/e ratio of 13 – around 25% less than today. As a result of its high operational gearing, I also believe its juicy operating profit margins at more than 15% could prove vulnerable in a downturn.

Recommendation: TAKE PROFITS at 302.25p

Paul Hill also runs a highly successful share-tipping service; click here to find out more: Precision Guided Investments.