The most striking thing about the business services sector is its sheer diversity. It houses recruiters, hire companies, workwear suppliers and pest control specialists. Yet these disparate players have something that binds them. They are all reliant on corporate customers being willing and able to pay for their services. That depends to a large degree on how much confidence those customers have in the economy.
Heading into 2017, there remains a fair amount of uncertainty. Business confidence took a knock immediately after the EU referendum. Shares in recruiters Hays (HAS) and PageGroup (PAGE) were especially hard hit on worries that hiring decisions, particularly those in financial services, would stall. Earlier this month, both companies released full-year trading updates that told the same story: uncertainty on their home turf had reduced net fee income, but this was made up for – especially in the case of PageGroup – by strength in continental Europe and Asia Pacific. Global diversification is currently demonstrating its worth.
We should add, though, that France and Germany, which have been pillars of strength, face challenges this year. With important elections in both countries, this rich seam of growth could look shakier by the year-end. The recruiters do at least have the buffer of net cash positions and analysts expect both Hays and Page to review prospects for special dividends at the next full-year results.
Things could be improving on the home front, though. The latest survey of finance chiefs by consultancy Deloitte suggests Brexit-related jitters have receded to some extent, with company bosses feeling more optimistic than at any time in the past 18 months. But Deloitte warns that this “does not represent a return to business as usual”, with chief financial officers expressing very high levels of uncertainty and a reluctance to invest.
Sterling depreciation was a major theme last year, casting a rosy glow over results from staffers with overseas operations as well as distributors such as Electrocomponents (ECM). Admirable cost-cutting and a bid tussle over peer Premier Farnell conspired to make Electrocomponents the best-performing stock in the sector last year: in fact, its stock market value doubled over the calendar year. The sterling tailwind will continue to flatter numbers for the distributors in the first part of 2017, but will unwind later in the year. That may well make it all too evident that the company continues to operate in a low-growth environment. With valuations looking full, we stay neutral on this subsector.
Another expected theme this year is a pick-up in infrastructure projects, particularly in the US under President Trump. Hire company Ashtead (AHT) is blessed with a large exposure. But its shares are trading ahead of their historic average on close to 16 times forward earnings, and there is the ever-present risk that campaign promises do not make it through the fiscally conservative US legislature. So we favour peer Aggreko (AGK) for performance this year.
We tipped the company last May (Buy, 1,167p, 26 May 2016) because we believed power demand in emerging markets would catch up with cheaper oil, driving recovery in the group’s key utilities business. Downbeat half-year results last summer shook confidence. But a reassuring autumn trading update suggests the recovery could be coming good. Order intake for utility-grade power plants topped one gigawatts in the first nine months of 2016. That’s getting on for double the output from the prior comparable period.
Elsewhere, acquisitions and divestments will remain topical as players seek to convince investors of their superior growth prospects. Rentokil (RTO) recently jettisoned part of its workwear and hygiene business into a joint venture for €520m (£455m) cash; expect the group to spend up to £100m on bolt-on acquisitions as it sharpens its focus on pest control this year. Bunzl (BNZL) and Intertek (ITRK) will also remain acquisitive as they seek to supplement flat organic growth.
| Price (p) | Market value (£m) | PE (x) | Yield (%) | 1-year change (%) | Last IC view | |
| AA | 270 | 1,646 | 12.3 | 3.4 | -2.5 | Hold, 288p, 28 Sep 2016 |
| Aggreko | 1,032 | 2,643 | 16.7 | 2.6 | 31.0 | Buy, 963p, 04 Jan 2017 |
| Ashtead | 1,593 | 7,953 | 17.9 | 1.5 | 67.7 | Hold, 1,609p, 19 Jan 2017 |
| Berendsen | 873 | 1,506 | 14 | 3.5 | -15.5 | Hold, 1,293p, 02 Aug 2016 |
| Bunzl | 2,137 | 7,172 | 22.3 | 1.8 | 21.4 | Hold, 2,464p, 30 Aug 2016 |
| Carillion | 236 | 1,014 | 6.7 | 7.8 | -15.3 | Buy, 238p, 04 Jan 2017 |
| DCC | 6,125 | 5,437 | 25.5 | 0.0 | 22.4 | Hold, 6,505p, 15 Nov 2016 |
| Diploma | 1,010 | 1,144 | 24.1 | 2.0 | 53.0 | Hold, 913p, 22 Nov 2016 |
| Electrocomponents | 482 | 2,128 | 29.2 | 2.4 | 117.1 | Hold, 387p, 21 Nov 2016 |
| Essentra | 444 | 1,167 | 10.1 | 4.7 | -40.2 | Hold, 397p, 22 Nov 2016 |
| Experian | 1,551 | 14,651 | 22.5 | 2.2 | 38.2 | Hold, 1,453p, 09 Nov 2016 |
| Hays | 155 | 2,237 | 17.8 | 1.9 | 36.8 | Hold, 125p, 01 Sep 2016 |
| Homeserve | 609 | 1,888 | 27 | 2.1 | 48.9 | Hold, 591p, 24 Nov 2016 |
| Intertek | 3,462 | 5,587 | 22.8 | 1.6 | 30.4 | Hold, 3549p, 01 Aug 2016 |
| IWG | 257 | 2,365 | 18.9 | 1.8 | -10.7 | Hold, 263p, 29 Sep 2016 |
| PageGroup | 425 | 1,386 | 18.5 | 2.7 | 9.9 | Buy, 392p, 11 Mar 2016 |
| Rentokil Initial | 221 | 4,039 | 24.3 | 1.4 | 47.1 | Hold, 214p, 29 Jul 2016 |
Favourites: Investor confidence is returning to Aggreko, with the shares up a quarter in the past two months. There are still risks given the large exposure to emerging markets. But the rating looks undemanding. The shares trade on 15 times 2017 forecast earnings, at the time of writing; that’s a slight discount to peers and far below the rating of a couple of years ago.
Outsiders: We have stuck with our tip on Carillion (CLLN) (Buy, 341p, 18 December 2014) despite headwinds. The general election and then the EU referendum were blamed for delays in public sector contracts, while weak oil prices hit Middle Eastern work. Earnings have stagnated in the past four years and City consensus is for flat earnings this year, too. A bit of selling pressure might have been absorbed – there is, after all, still a chunky dividend yield and large order book.
