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Government efficiency to buoy support services

The same story that played out in 2010 for many support services companies will continue a new chapter into 2011. The sector was dominated last year by the general election and talk of spending cuts as many companies witnessed a hiatus of contracts in both the private and public arena. As predictions of government job losses hit the headlines, those companies with the highest exposure to the UK as a percentage of revenues saw their share prices flounder. Further compounding the misery, Cabinet Office spending axeman Francis Maude was ruthless in his rhetoric, asking the major suppliers to government to compromise margins.

But now, with the comprehensive spending review behind us and clarity on central and local government departments' budgets, we should begin to see more positive newsflow from many in the sector in 2011. That's because outsourcers' and consultants' forte is cutting costs - exactly what the government wants to achieve.

And importantly, the market for prospective work remains large. Both the Julius report, commissioned by the previous Labour government in 2008, and Ovum, a think tank, indicate that £100bn-worth of public services in the UK could yet be contracted out, compared with just £15bn currently. Mr Maude previously indicated that there would be a structural shift to the private sector and this process is already taking place at the local government level. Opportunities look promising as budgets are chopped 28 per cent over the next four years, with some county councils, such as Suffolk, pledging to cut budgets 90 per cent in the next 10 years. The aim for many councils is to become an "enabler", making the decisions and outsourcing the work. So consultants will guide them on their way, while outsourcers will become the end product.

The most highly-rated companies in the sector are the outsourcers with a proven track record and boasting diversified revenues in both the private and the public sector. Serco and Capita recently signed deals with the Cabinet Office to help cut costs and lower margins. But both said that this will not materially affect profits because the groups also have large, successful private sector operations that continue to expand. Even on high forward multiples of 16.5 and 14 times earnings respectively, the shares look attractive. The companies whose shares trade on the lowest PE ratios are those that saw large parts of their market capitalisation wiped out in 2010. Xchanging felt the lull in deal making, which, coupled with concerns over accounting policies, led to a 44 per cent fall in its share price. Trading on 7 times forecast earnings, the company aims to become an international player and broaden its customer base.

Due to the cyclical nature of the sector, this diversification is likely to be an important goal for many. Successful expansion overseas will be crucial in 2011, particularly as equipment rental specialists like Ashtead and materials distributors such as Wolseley are heavily dependent on developments in the domestic construction market. This pair might still struggle in 2011 as construction is not expected to repeat the strong growth of the past year. WS Atkins will be shielded from some of this pain having made a game-changing US acquisition back in August that cut the UK's proportion of group revenues by a third to 54 per cent. And many in the sector already have large diversified businesses overseas. Electronics distributors Premier Farnell and Electrocomponents are currently trying to win business in a fragmented US market and develop their online offering. Both are witnessing revenue growth over 20 per cent, and as a result, they are rated highly on 17 times earnings, boasting modest yields.

Temporary power specialist Aggreko also has large overseas exposure and is highly rated in the sector due to the success of its International Power Projects business in North America. This was buoyed in 2010 by the Vancouver Winter Olympics and the BP oil spill. Credit specialist Experian and security outsourcer G4S both also have large American operations, but their real focus for growth is Brazil. Having made targeted acquisitions in the past few years, Experian is the biggest international player in the country, while G4S is the largest security specialist. Reflecting its global ambitions and proven track record, Experian trades on a hefty 18 times earnings, while G4S is at a discount to outsourcing peers on 12.

Finally, repairs and maintenance provider HomeServe is also expanding overseas successfully, particularly in the US after the acquisition of National Grid Energy Services' customers, with numbers in the region increasing 68 per cent to 828,000. The company's penetration into its marketable customer base is still relatively small compared to the UK, offering vast opportunity for growth.

NAMEPRICE (p)MARKET CAP (£m)PE RATIOYIELD (%)1 YEAR PRICE CHANGE (%)LAST IC VIEW
AGGREKO1474404321.51.058.1
ASHTEAD GROUP17186190.11.7104.9
ATKINS (WS)6806818.64.17.6
BABCOCK INTL.575206112.33.1-4.0
BERENDSEN4407514.69.4
BUNZL745245315.63.012.9
CAPITA GROUP6954255172.5-6.4
CARILLION37815119.73.923.6
CPPGROUP3155370.0
DE LA RUE83582714.35.1-16.0
ELECTROCOMPONENTS274119416.94.066.2
EXPERIAN785789718.22.129.7
FILTRONA25051416.93.241.2
G4S261368212.92.8-2.6
HOMESERVE441145019.51.528.9
HOWDEN JOINERY GP.10767846.50.037.6
INTERTEK GROUP1772282721.21.541.8
MITIE GROUP24085711.93.41.9
PREMIER FARNELL302111217.73.274.3
REGUS9690413.52.54.1
RENTOKIL INITIAL98178237.30.0-14.6
RPS GROUP22047712.91.90.1
SERCO GROUP562277217.51.26.5
SHANKS GROUP12348619.52.5-6.1
SIG13378519.50.011.2
TRAVIS PERKINS10562551140.027.5
WOLSELEY204558180.050.3

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