Shares: Hays delivers the goods

The food distribution and office support services group has finally made it into the big boys' club

Last week saw the realisation of a long-standing ambition for Ronnie Frost, the chairman of Hays, the Rentacrate-to-food distribution and recruitment group. After more than a decade in the driving seat, the group he has taken from a management buy-out in 1987 was granted membership of Britain's most exclusive business club, the FT-SE 100 index.

Something of a flat performer when it was floated in 1989, earnings at Hays only really started to take off from 1992. But the company has been one of the best stock market performers ever since. From flotation, its shares - now at 537.5p - are up fivefold, and have outstripped the FT All-Share index by a staggering 400 per cent over the same period, with a particularly stellar showing in the last two years.

Such returns have generated an intensely loyal City following and few would question the management expertise behind the recent track record. Nor has growth been driven by acquisitions - a common misreading of a group which has been a frequent shopper for other companies. In fact, these have usually only been bolt-on deals. Indeed, over the last few years, Hays' acquisition track record has not always been one to boast about.

A proposed pounds 1bn-plus approach for Christian Salvesen, the food distribution group, was rejected this year. On a smaller scale, Mordhorst, its German distributor, has seen profits slip since Hays paid pounds 32m for a 75 per cent stake in 1993.

Coupled with Fril, its French distribution arm, however, the group is en route to creating a pan-European delivery network. Mr Frost says Europe is 15 years behind Britain's sophistication in this area.

Winning contracts in the current climate is a tough job, but what has been achieved in the UK can show the uninitiated the savings that can be made. Therein lies the ability to win fairly decent margins, although Mordhorst has suffered here, partly because of the recession still wreaking havoc in Germany.

In the UK, Hays added to its firepower in September when it bought ICS Corporation for pounds 65m. ICS offers customers an early morning parcels delivery service through a nationwide depot network, and delivers 800,000 items a day.

The deal complements Hays' Document Exchange, which serves insurance, travel, optical health and government sectors. Hays has a major presence in overnight mail, and ICS should help boost its range of services.

But the mainstay of growth has been organic - a feature it shares with another wonder stock, Rentokil, once touted as a possible bidder for Hays. As is being seen at Rentokil, however, the ability to continue creating fabulous shareholder returns diminishes over time. The truism, the bigger you get, the slower you move, still holds good. Nevertheless, it should be a few years yet before the Hays magic fades.

Like Rentokil, the company regards itself as a niche operator, always with the objective of becoming number one or two in each chosen area. For example, it claims to be the leader in accountancy, banking and insurance personnel.

Hays is built around three core divisions: distribution, office support services, and personnel. While distribution remains the largest, it is personnel that has surprised most. Profits there have risen sharply, far surpassing market expectations.

Much of the upturn has come on the back of a resurgent economy. Increased demand for temporary staff to plug the holes left by downsizing has helped. Both these phenomena, however, have begun to run their course. There are worries that the shares have been over-dependent on the personnel factor, and that if it fades, a de-rating will happen.

Food distribution in the UK - where Hays has had a long-standing relationship with Waitrose and numbers Marks & Spencer among its supermarket customers - has become ferociously competitive. Mr Frost says the UK sector is ripe for consolidation: "It is time the logistics industry realised turnover is not important; it is profits."

Hays should be able to continue to show impressive growth from existing operations, but observers saw another avenue in the pounds 1.1bn offer for Salvesen. Spurned by family shareholders, though, Hays bowed out.

Since then, Mr Frost has stated that the group has no intention of making hostile offers. Nor is Hays looking to mop up other quoted rivals, he adds.

Next year, it looks as if forecast pre-tax profits of pounds 153m, up from pounds 132m, are within its grasp. Even so, the shares trade on a demanding 20 times next year's earnings, a 20 per cent premium to the market. For now, that looks to be justified. Further out, however, the question of how the company can sustain such growth will become more pressing. Analyst Andrew Ripper, of brokers Merrill Lynch, says: "Hays has been driven by the success of its recruitment business. After that cycle declines, it is harder to see where growth will come from."

Perhaps acquisitions, on a grander scale, will plug the gap. Despite denials, there is the added spice of a possible renewed bid for Christian Salvesen, after it demerges its Aggreko plant hire business. Such a move would appeal to investors, given that Hays would only have to cough up pounds 600m or so.

Hang on for the ride.

Hays

Share price 537.5p

Prospective p/e 20*

Gross dividend yield 2.0%

1994 1995 1996 1997* 1998*

Turnover (pounds m) 632 808 966 1,125 1,240

Pre-tax profits (pounds m) 88 110 132 146 175

Earnings p/s (p) 14.7 18.7 22.3 25.7 29.2

Dividend p/s (p) 6.1 7.0 8.1 9.3 10.6

*BZW forecasts