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FTSE 350 Outlook: Support Services

Created:

22 January 2008

Written by:

Algy Hall

It's a testament to the diversity of the support services sector that as well as containing some of the companies that look most vulnerable to a potential economic downturn in 2008, it also plays host to a number of the market's most exciting defensive plays.

Falling firmly into the downturn-sensitive category are the recruitment stocks. At first glance, it may seem a bit strange that these companies fared quite as badly as they did during the second half of 2007 given the strong trading they have been reporting. For instance, sector bellwether Michael Page last week revealed a 38 per cent increase in gross profits in the final quarter of last year. And rival Hays has gone as far as declaring itself "confident in its outlook for the [2008] year", after increasing net fees by 27 per cent in the final quarter of 2007. However, when the market turns on recruitment firms it tends to do so with a vengeance. And as the credit crunch spreads it has begun to look increasingly likely that recruiters will feel some pain. Indeed, this chill wind prompted the Investors Chronicle to downgrade its sector favourites from buy ratings in December. That said, it's not inevitable that these companies' profits will be decimated in 2008. A shortage of candidates in the job market for professionals should help cushion trading. What's more, recruiters have learnt from past slumps and many have diversified into international markets, such as Europe where there is structural growth, and the booming Asian markets. So these companies do have potential as one of 2008's big contrarian bets, but their cyclical nature means share prices could still go a lot lower before they find the bottom

Equipment and plant hire companies also endured a tough end to 2007 due to credit crunch concerns. Here, there's more scope to question the grounds on which companies such as Ashtead and Speedy Hire have been de-rated. That's because the construction industry, which is the key end-market for these companies, still looks in good health despite the trouble being experienced in the residential and commercial property markets. Indeed, big public projects, such as the 2012 Olympics, are helping to buoy the sector. Nevertheless, the potential remains for the credit crunch to cause further problems. Investors' fears are also being heightened by the large amount of debt carried by Ashtead and Speedy Hire, and, in the case of Ashtead, its heavy exposure to the US and its past brush with near collapse. The problems afflicting these hire companies have not weighed on their peer Aggreko , which specialises in renting out temporary power supply equipment, though. It is experiencing burgeoning demand from emerging economies with weak infrastructure. Companies offering support services to the public sector have fared well in 2007 and once again look set to offer the attractions of both defensiveness and growth this year. A key theme here is the drive towards outsourcing to reduce costs in the public, regulated and private sectors. One of the raciest parts of the outsourcing market is business process outsourcing (BPO) and in 2007 two new listed players emerged taking the total tally to three. Capita got its first real peer when Xchanging floated in April and then Mouchel joined the gang with the acquisition of HBS in August.  

Companies such as Serco, Interserve and Connaught also continue to profit offering blue collar services to the public and regulated sectors. Meanwhile, waste companies Biffa and Shanks are set to benefit from spending increases prompted by EU landfill targets. In fact, these strong prospects helped attract a bid for Biffa late last year despite the trouble in the credit markets. And engineering consultancy businesses, such as RPS and WS Atkins , are also doing well from big public projects as well as private and regulated sector work

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