The Stock

What to trade: Buy True Blue (NYSE: TBI) < $15.25 with a stop-loss @ $11.50.

Why Now: Temporary staffing always picks up early in an economic recovery, as employers are reluctant to take on the expense of hiring full-time employees. In September US temporary payrolls soared nearly 24 percent from a year ago. Meanwhile, increasingly inflexible, European-style regulation of the US labor market is forcing companies to make greater use of temps.

Buy True Blue under $15.25 with a stop at $11.50.

The Story

With the mercury climbing to an unseasonably warm 74 degrees Fahrenheit, Yiannis and Elliott decided to meet on the patio of one of their favorite local restaurants, Lebanese Taverna, for a final lunch al fresco before the onset of winter. After waiting 15 minutes for Elliott to arrive, Yiannis rings his mobile to remind him about the meeting.

Elliott: Hello, Yiannis.

Yiannis: Where are you, man? I can barely hear you.

Elliott: I’m on Interstate 66, enjoying one of my last opportunities to drive with the top down. I just got out of traffic around the Dulles-Metro link construction project. I should be there in five minutes, if people start to drive properly instead of slowing down to stare at the cranes.

Yiannis: Relax, man. Enjoy the weather and think about the bottle of wine that’s waiting for you at the table.

Elliott: I need it. I’ve already had enough caffeine. Why are you in such a big hurry for me to get there? Did you forget the small wager at our last Stocks on the Run meeting? Not even a week after our bet Rahm was on a plane to Chicago, leaving his erstwhile boss to face the midterm elections alone. I want my money!

Yiannis:  Don’t worry, man. I didn’t forget our bet; I’ve got your cash right here.

Elliott: In that case, I’ll see you in five.

About 10 minutes later, Elliott makes his entrance at Lebanese Taverna, greeting all of his friends at the restaurant. Within a few minutes, he’s on the patio, where Yiannis greets him with a glass of Greek white wine and a bottle of San Pellegrino.

Yiannis: That was a long five minutes.

Elliott: Don’t start. You know I’m never on time during earnings season. Plus, all this construction makes midday traffic as bad as rush hour. Is Roger coming?

Yiannis: Roger said he’d join us at 2:30 for a late lunch.

Elliott: I bet you he won’t show up on time. About 10 of the names in his coverage universe reported earnings last night. He sent me an incoherent email at 3:30 am last night; we probably have a couple hours to talk about our next pick for Stocks on the Run.

Yiannis: No more bets–I learned my lesson last time. I’m still not convinced that you didn’t get inside info from Rahm when you swiped his seat at the bar.

Elliott: I’d love to hear more of your conspiracy theories, but let’s get down to business before the wine starts flowing. I’ve got an idea that relates to one of the themes we covered in our book. Check this out.

Elliott slides a piece of paper across the table.

Yiannis: I hope that’s not an invoice for our bet.  

Elliott: Ha! It seems you’ve been thinking more about the bet than I have. It’s the September employment report from the Bureau of Labor Statistics. As you know, the US created about 64,000 private jobs in September. Discussions about the lack of new jobs are old hat at this point; over the past 12 months, US nonfarm payrolls grew by less than 0.6 percent.

But look at the line I highlighted. The number of temporary jobs is soaring. Total temporary staffing in the US is up nearly 24 percent from a year ago–a record rate of expansion–and growth continues to accelerate.  

Yiannis: In Europe, outfits that provide temp staffing are much bigger than in the US.

Elliott: That’s right. The biggest temporary-staffing firms in the world include Adecco (Switzerland: ADEN) and Randstad (Holland: RAND). Manpower (NYSE: MAN) is headquartered in the US, but France is its single biggest market.

An inflexible labor market explains the prevalence of temporary-staffing outfits in Europe. You Europeans don’t let companies lay off workers without providing them with a substantial severance package. You also have onerous social taxes, ridiculously short work weeks and mandatory paid leave for everything. Every time someone breaks a fingernail, it’s off to Mykonos for three weeks or a cushy early retirement.

Yiannis: It’s not that bad!  

Elliott: Okay, maybe I exaggerated a bit, but you can’t deny that it’s a lot more expensive to hire full-time workers in Europe and even more expensive to fire them when the economy heads south.

Yiannis: That’s true, but your displeasure hasn’t stopped the US from heading in that direction.

Elliott: Unfortunately, my displeasure doesn’t carry much weight in Washington. But this trend is exactly what we wrote about in The Rise of the State. EU companies rely heavily on temp workers because they need the staffing but can’t afford to hire too many full-time employees because of regulations. Temps are the cheapest way for corporations to adjust their labor force.

US regulations are becoming more onerous, uncertainty surrounding many industries is on the rise, and the government is threatening to get involved in an effort to create jobs. Health care reform increases the cost of benefits that companies must provide to their employees.

The truth is that neither the government nor any private company knows how much the bill will cost and what it will mean for business.

New regulations aimed at the health care, financial and energy sectors increases uncertainty about future business conditions, which weighs on hiring.

In short, the US is gradually becoming a social democracy akin to the European model. I think such a move is a disaster waiting to happen, but nobody cares about my sociopolitical views–people want to know how we can make money from this transition.

Yiannis: The state is definitely getting more involved in US businesses than ever before, but the transition to a European-style social democracy will take years to play out. Stocks on the Run is all about trades and short-term gains. What’s going to power temporary-staffing names higher over the next few months? 

Elliott: You’re right–I got a little too excited about the Europeanization of the US labor market. But the pick still works as a trade. In the near term, the recovery cycle should power near-term growth for the company I have in mind.

In a normal cycle, companies begin to cut staffing costs as the economy cools and business conditions deteriorate. Initially, they reduce hours worked by cutting shifts in factories or through mandatory unpaid leave. Temp workers are next on the chopping block because they don’t receive the same severance pay and benefits as full-time workers.

Companies also don’t want to fire a bunch of people only to find out a few months later that the economy was going through a temporary soft patch. In that event, the firm would be forced to hire new people in a competitive environment. In economics class, we referred to this reluctance to lay off staff as labor hoarding.

Of course, once it becomes clear that a recession is looming or underway, companies inevitably sack full-timers to align costs with reduced demand.

In short, the level of temporary staff tends to decline before permanent staffing takes a hit. The decline in temporary staff also tends to be more severe in percentage terms because businesses don’t need as many temps during a downturn.

On the other hand, when business conditions begin to pick up, companies have to add labor. But businesses hesitate to take on new workers, fearing that the economic improvement could prove fleeting. Management will have existing staff work additional hours and then add temp workers to handle the increased business. In other words, temporary hiring recovers before permanent hiring in an upturn.

The current cycle has followed this pattern closely. On a year-over-year basis, temporary staffing began to shrink in April 2007, a year before total private non-farm payrolls. At the heart of the downturn, temporary staffing plummeted 27 percent year over year. Temp payrolls began to expand in February 2010–five months before the year-over-year change in total payrolls headed into positive territory.

Now we’re in the sweet spot of the cycle; growth in temporary payrolls is booming.

I rest my case.

Elliott takes a long sip of his white wine and leans back in his chair.

Yiannis: Maybe it’s the wine, but I think there’s a hole in your story. If most of the temporary-staffing firms are leveraged to European markets, how are people going to make money from this trend?

Elliott: I have two words for you, man: True Blue (NYSE: TBI).   

Yiannis: What? That sounds like the paint color I used in my kitchen. You’re talking nonsense again.

Elliott: True Blue is a small company that has a market capitalization of $600 million and some $140 million in cash on its balance sheet. The company is a leader in temporary staffing and specializes in providing blue-collar employees.

True Blue used to be called Labor Ready, and this brand still accounts for roughly two-thirds of the company’s business. The firm has a nationwide pool of workers who are available for short-term projects. True Blue manages its business via a network of 700 US branch offices and provides workers to a wide range of industries, including manufacturing, warehousing and construction.

True Blue’s other divisions supply skilled tradesman, manufacturing workers, truck drivers and aviation maintenance, repair and manufacturing specialists.

Some of these workers go out on multi-month placements that last for the duration of specific project. For example, in 2009 the company’s largest customer was Boeing (NYSE: BA), which was working on its 787 Dreamliner aircraft.

Yiannis: Has True Blue reported earnings yet?

Elliott: Management reported third-quarter earnings of $0.23 per share, $0.03 ahead of consensus expectations, and markedly increased the outlook for fourth-quarter revenue.

One bright spot stood out during the company’s conference call: US manufacturing activity has bounced back nicely from its recessionary lows, recovering at a faster pace than the service economy. This has been good news for True Blue.

Residential construction was up 10 percent in the third quarter–a temporary bump that reflects the first-time homebuyer subsidies that expired earlier this year. Nonresidential construction was down 10 percent this quarter, and management noted that demand for temp workers in this area remains weak. This weakness is a well-known issue and is more than offset by growth in other segments.

Yiannis: What about profit margins?

Elliott: Margins should be good next year. Profitability collapsed during the recession, but True Blue cut costs aggressively, shuttering about 200 branches in 2008-09. As the volume of temp placements returns, a lower cost base will ensure that profits increase rapidly. The company has also hiked the rates it charges firms to place staff, offsetting rising costs associated with higher state taxes for unemployment insurance.

Recovering demand among small and midsize businesses is another encouraging sign. Management reported an uptick in companies seeking one or two workers, and the firm earns a higher margin when it places these workers.

Yiannis’ eyes suddenly brighten as he spots the Big Yield Hunter himself, Roger Conrad, parking his car outside the restaurant.

Yiannis: Here comes Roger, and he looks thirsty. Let’s order another bottle of wine.

Elliott: As usual, I’m a step ahead of you. I already asked them to put another bottle on ice. What do you think about True Blue?  

Yiannis:  I like the story–let’s do it.

Elliott: I’m glad that’s settled. Speaking of which, where’s my money, man? This lunch is on you!

Yiannis pulls five crisp $20 bills out of his wallet and holds them up for Elliott to see.

Yiannis: I have a proposal for you. Let’s play two sets of court tennis at a time of your choosing–double or nothing.

Elliott: Ha, you’re on! Now you’re going to owe me $200.

Yiannis: We’ll see.   

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