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In which we serve: UK's 'invisible' exports

With an in/out vote on the EU looming into view, the subject of Britain's 'invisible' exports takes on a political dimension.
May 20, 2016

With this week's cover feature given over to the 'Brexit' debate it's perhaps apt that we've chosen to examine the issue of the UK's so-called 'invisible exports'. Those seeking to preserve our existing ties with the European Union (EU) have pointed out that these types of service sector exports could be imperilled in the event of a No vote. That's because the UK would probably find it much harder to secure a free trade deal with the EU covering the services sector, as opposed to the goods sector. You could certainly argue that there are split incentives either side of the trade divide: the UK runs a deficit with the EU in goods, but a surplus in services.

Our ability to export specialist skills abroad has underpinned the expansion of Britain's global role in financial services. And contrary to the prevailing media consensus, there are certainly risks attached to maintaining the status quo in Europe. Our ability to influence European rules is under threat even if we remain in the EU. Financial regulation is increasingly being pushed through with qualified majority voting over which there is no veto. And the Prime Minister's renegotiation deal with Brussels explicitly rules out a British veto on eurozone integration measures.

The likelihood is that any post-Brexit trade negotiations would descend into the usual round of horse-trading; diplomatic impasse usually gives way to financial expediency. But you never know; trade commissioners in Brussels might be inclined to dig their heels in over any future trade arrangements, so the in/out referendum certainly qualifies as a potential risk factor for the UK's service sector exports.

 

Our 'invisible' success story

And what a success story they've been. According to think-tank Open Europe, the UK's financial services and insurance industries ran respective trade surpluses with EU countries of £16.1bn and £3.85bn. Compare that to the £16.6bn deficit we run with our continental partners for food, beverage and tobacco.

The UK's invisible exports are generated through the private and public spheres and across a range of sectors. They cover specialist expertise in law, corporate communications, public-sector outsourcing, recruitment and management consultancy — to name but a few. Many would be surprised to learn that the UK is the second-largest exporter of services in the world behind Uncle Sam, and export-led services industries now account for around a third of gross domestic product. The services sector has also been the principal driver of employment growth — resulting in the creation of over 1m extra jobs in the UK since the 2008 financial crisis, despite cutbacks in the public sector.

 

 

The 'blue collar' transition

And yet we're still told that the UK economy is essentially unbalanced — whatever that means — and that manufacturing is perennially on its last legs. However, we should bear in mind that manufacturing output has increased in real terms since its supposed heyday in the 1950s. We're talking about relative decline.

Nevertheless, it's obvious to anyone that many traditional blue collar jobs in the West have been exported to lower-wage economies since the early part of the 1970s; a consequence of rising real wages and the abolition of quota and tariff systems. The percentage of jobs in manufacturing and industrial production has steadily declined. In 1980, a quarter of jobs were in manufacturing. By 2010, the percentage of jobs in manufacturing had fallen to 8.2 per cent.

This obviously causes major social upheaval and distress for workers. But many would argue that the transition was inevitable in a globalised market and that we shouldn't let a sentimental attachment to manufacturing and heavy industry skew business decisions. For instance, there may well be a compelling strategic rationale for ensuring that Britain retains a steelmaking industry, but it may prove rather more difficult to justify its continued survival from a purely commercial standpoint.

Offshore growth opportunities

Of course, part of the reason why many companies in the services sector are targeting overseas growth is simply because the pace of outsourcing in the domestic market has slowed. G4S (GFS), for instance, may still be struggling with unprofitable legacy contracts and a lingering PR problem, but the security giant recently highlighted a step-up in revenues from outside the UK. G4S has just secured a £1bn renewal contract to manage the Port Philip prison in Victoria, Australia, for another 20 years. With less than 10 per cent of Australia's prison network privatised, and a new commitment from the state government in New South Wales to open up the market to the private sector, it's little wonder that G4S and UK rival Serco (SRP) are looking at Australia to fuel growth.

The involvement of the private sector in the running of correctional facilities remains a contentious issue, but competition is still intensifying in this space. Other UK-based support services groups have gained traction abroad simply as a result of specialist expertise. A corporation like Experian (EXPN) has been able to adapt and expand its product range beyond credit scoring, while entering dozens of new regions such as Latin America, Asia Pacific and eastern Europe. Rentokil Initial (RTO), which grew out of Imperial College's school of entomology, has been trading on specialist intellectual property for the best part of a century. Again, the group has broadened its service offering, now divided along three main business lines of pest control, hygiene and workwear, and now serves customers in 60 countries across five geographic regions.

IC VIEW:

Analysis by PwC, covering the growth of service sector exports, states that the most successful companies have been quick to exploit the growth in demand from abroad. And rather than any rebalancing towards manufacturing, the services sector, itself, has been transitioning towards a higher-growth export model. The report concludes that there is still potential for the UK to take advantage of expanding trading opportunities in services. This is partly due to the growth of Asia's middle class; as median incomes rise, there is a commensurate increase in demand for service industries. Furthermore, the ascendancy of the sector shouldn't be viewed as a source of economic weakness. Indeed, unit profitability within value-added service industries has increased relative to manufacturing as the comparative advantage shifts away from labour-intensive industries to those that are 'tech' and service sector based.

Favourites

You would be hard pressed to find a better example of how a UK corporation has utilised decades-old experience to capture overseas business than Charles Taylor (CTR). The group has been trading in one form or another since 1840 and its rate of progress over that period mirrors the fortunes of the UK insurance industry — the cornerstone of the City's financial services sector. The group's management services business serves the mutual market and manages the Standard Club, which provides protection and indemnity insurance to around 10 per cent of the global shipping industry. The group provides professional services to insurance businesses in the UK, the Americas, Asia Pacific, Europe and the Middle East. Operations are divided into four segments: management services, adjusting Services, insurance support services and insurers in run-off – effectively a full-service offering. Given that Charles Taylor has demonstrated an ability to consistently increase revenues, earnings and dividends over the past five years, a forward multiple of 13 combined with a forecast yield of 4.2 per cent looks like excellent value.

Outsiders

De La Rue's (DLAR) share price recently surged on news that underlying operating profits are now predicted to come in at £62m for the year to March 2016. The figure is in advance of City estimates, and would have come as a welcome relief to shareholders after a steady stream of profit warnings in recent years. As the world's largest bank note printer, De La Rue has established a significant presence in overseas markets, but that obviously comes with risk attached. In 2010, the group's share price tumbled after the Reserve Bank of India pulled De La Rue's largest contract on quality control issues — and it has struggled to get back on good terms ever since. De La Rue trades broadly in line with the sector, albeit with a juicy yield in excess of 5 per cent. However, more evidence is needed that the group has adapted to the structural challenges in its key markets. Hold.