Seek finds a way to offset declining market

An IGA supermarket in Edgewater, Western Australia, recently placed an advertisement in a newspaper for a part-time retail assistant.

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THE owner of an IGA supermarket in Edgewater, Western Australia, recently placed an advertisement in a community newspaper for a part-time retail assistant.

Usually, this type of position attracts a handful of responses. But in this instance, the owner had to stop accepting applicants when the number hit 140.

The job market in Western Australia is slowing dramatically. In fact, the Australian Bureau of Statistics has released data that showed there were more unemployed people in WA during the March quarter than during the peak of the GFC.

Job advertisements serve as a leading indicator for the unemployment rate, and numbers have been in steady decline since the start of the year. We at Montgomery Investment Management have been closely monitoring this trend because of the significant relationship it has with the earnings of one of our major holdings, Seek.

Seek is Australia's leading job website, with 75 per cent of the listed advertisements in the domestic market. Seek's business model is driven by job listing fees, and traditionally its earnings per share has exhibited a remarkable correlation with the total number of internet job advertisements. The chart below plots this relationship. You can see from the chart that prior to 2009, earnings tracked online ads very closely. But in the period after 2009, earnings recovered far quicker and continued to increase while the number of ads declined. What explains this divergence?

Seek management foresaw that the domestic advertising market would eventually mature, and sought to diversify the company's earnings by acquiring online education providers. Education serves as a natural hedge against a falling jobs market - people are more inclined to further their education when the market is in a downturn.

Management began acquiring educational providers in 2004, and was able to successfully integrate these businesses before the GFC hit in 2008. This served to insulate the group's earnings.

Management continued to diversify earnings by investing overseas. While the company expanded into New Zealand in 1999, it wasn't until 2006 that the company aggressively pursued international interests. Management's strategy has been to acquire small stakes in international job boards, and slowly increase these stakes as the businesses grew their earnings. Seek now has interests in China, Mexico, Brazil and greater Asia. The international division is now providing the catalyst for growth as domestic earnings plateau.

The domestic advertisement division now comprises 65 per cent of Seek's earnings, which compares to a 90 per cent contribution in 2008. Despite this diversification, risks remain to the company's profitability if the domestic job market continues to weaken. When you examine the chart, you will note that the number of job advertisements is nearing the lows of the GFC, and this trend seems likely to continue.

Seek has the ability to limit the impact on earnings from declining volumes by raising prices. Seek provides a service that is in such high demand that it is able to review prices each year without a significant decrease in its customer base. From July 1, Seek will increase the price of a standard job ad by 5.5 per cent.

Seek is a quality business which we will continue to hold in our portfolio, particularly because the company is in a much stronger financial position than it was during the previous downturn. In saying that, we are never able to predict short-term share prices.

But there is one thing we do know. IGA stores in WA are going to have the most efficient shelf-stackers in the country.