For a sector as diverse as business services, it is unsurprising that as we enter 2016 the prospects of the companies within it are mixed. However, where we are in the economic cycle, or rather where investors think we are in the cycle, is a common indicator of how a number of UK-listed business services groups may perform over the next year.
Investor sentiment towards the recruitment sector seems to have taken a negative turn. Buy tips Michael Page (MPI) and Hays (HAS) have fallen substantially since the summer, with shares in the latter now 9 per cent below our original tip. It is not hard to see why the shares have taken a turn for the worse. In the last quarter both recruiters revealed a slowdown in UK growth and macroeconomic pressures in the Asia Pacific region, including China and Australia.
The performance of the recruitment industry is linked as much to people's perception of the economic cycle as the reality. Analysts at Numis think that, while "a combination of FX and the breadth of investment has constrained the potential for earnings upgrades in FY2015E", at Michael Page the recruiter's permanent bias could generate earnings upgrades this year. Hays suffered analyst downgrades to its forecast EPS this year after its second-quarter update revealed a greater weighting to the lower-margin Europe and rest-of-the-world businesses. We are still positive on the sector, as both Hays and Page have strong balance sheets. Analysts at Jefferies are still forecasting 10 per cent EPS growth for Hays in 2016, while the less mature Michael Page is still converting only around half its fee income into profit compared with its 2007 peak.
Tool hire group Ashtead (AHT) and van rental group Northgate (NTG) have also faced market scepticism of late, with shares in the latter slumping to a 12-month low earlier this month. For Ashtead, fears of overcapacity in the US tool hire market were cause for concern. But the group is steadily reducing its exposure to the cyclical construction market and lending out more equipment to utilities and maintenance services companies. Ashtead put in a solid performance during the first-half of FY2016 and, given that its shares are still recovering from overcapacity concerns, we think there is more upside to come.
Northgate is also reducing its exposure to the construction market, particularly in Spain, and concentrating on small- and medium-sized enterprise clients. EPS is expected to take a hit in 2016, before returning to growth the following year. The shares are trading on just 8 times forward earnings, which, considering the 3.8 per cent prospective yield this year, keeps us positive on the group.
Weak oil and gas prices have not just hit producers, but also the companies servicing them. Aggreko (AGK), which provides temporary power to upstream and downstream operators in the North American market, has suffered margin erosion and a fall in revenue. Security issues in Yemen and Libya added to the company's woes and its share price has halved since we tipped them as a sell in February. Management will continue to put the group's recovery plan into action in 2016, targeting £70m in cost savings by 2017 and aiming to deliver operating margins and return on capital of around 20 per cent in the medium term.
Support services group Interserve (IRV) has managed to continue generating growth from supplying project management and operational services to the Middle East oil and gas industry. The group's full-year FY2015 results will be delivered later this year, but during the first half the group's international support services business grew revenue by more than a third to £103m. Infrastructure investment, predominately in the UAE and Qatar, drove similar growth for Interserve. But the group's UK construction business is expected to have performed less well when it reveals its full-year results for 2015, due to three lossmaking contracts caused by subcontractor insolvencies. Analysts at Peel Hunt expect this business to break even during FY2015, although they retain their pre-tax forecast of £119m. Meanwhile, the UK equipment services business is still going strong. A bounceback in UK construction could drive further upside in 2016.
| NAME | Price (p) | Market cap (£m) | PE (x) | DY (%) | 1-year change (%) | Last IC view: |
| AA | 282 | 1,713 | 14.2 | 1.2 | -19.1 | Hold, 305p, 22 Sept 2015 |
| AGGREKO | 806 | 2,063 | 10.6 | 3.4 | -48.0 | Sell, 918p, 30 Dec 2015 |
| ASHTEAD GROUP | 968 | 4,872 | 14.2 | 1.7 | -7.0 | Buy, 1,117p, 9 Dec 2015 |
| BERENDSEN | 1,039 | 1,793 | 17.4 | 2.9 | -6.1 | Hold, 1,016p, 2 Aug 2015 |
| BUNZL | 1,772 | 5,940 | 20.0 | 2.1 | -5.2 | Hold, 1,729p, 24 Aug 2015 |
| DCC | 5,060 | 4,478 | 24.1 | 1.8 | 46.5 | Buy, 5,655p, 10 Nov 2015 |
| DIPLOMA | 673 | 762 | 17.6 | 2.7 | -10.7 | Hold, 645p, 17 Nov 2015 |
| ELECTROCOMP. | 222 | 978 | 18.3 | 5.3 | 9.0 | Sell, 237p, 20 Nov 2015 |
| ESSENTRA PLC | 746 | 1,957 | 16.8 | 2.5 | -5.9 | Buy, 913p, 4 Aug 2015 |
| EXPERIAN | 1,152 | 11,062 | 23.9 | 2.3 | -0.3 | Sell, 1,223p, 11 Nov 2015 |
| HAYS | 118 | 1,684 | 15.8 | 2.4 | -21.9 | Buy, 158p, 28 Aug 2015 |
| HOMESERVE | 406 | 1,249 | 21.0 | 3.0 | 22.7 | Hold, 416p, 17 Nov 2015 |
| INTERSERVE | 474 | 689 | 7.7 | 4.9 | -7.8 | Buy, 610p, 12 Aug 2015 |
| INTERTEK GROUP | 2,725 | 4,397 | 19.6 | 1.8 | 13.9 | Sell, 2,625p, 5 Nov 2015 |
| MICHAEL PAGE INTL. | 393 | 1,279 | 18.9 | 2.9 | -15.5 | Buy, 550p, 13 Aug 2015 |
| NORTHGATE | 353 | 470 | 7.1 | 4.3 | -41.1 | Buy, 400p, 2 Dec 2015 |
| PAYPOINT | 842 | 573 | 13.6 | 4.8 | -5.1 | Hold, 907p, 8 Jan 2016 |
| REGUS | 294 | 2,735 | 24.5 | 1.4 | 42.1 | Buy, 266p, 25 Aug 2015 |
| RENTOKIL INITIAL | 152 | 2,778 | 18.4 | 1.8 | 22.4 | Buy, 144p, 2 Aug 2015 |
| WORLDPAY GROUP | 302 | 6,044 | NA | 0.0 | NA | n/a |
Favourites
Shares in workspace provider Regus (RGU) are 21 per cent up since our May buy tip, but we think there is further upside to come. The group delivered 155 per cent pre-tax profit growth during the first half of the current financial year. This is largely thanks to the fact that it has rapidly expanded its network of locations, but crucially not at the expense of weakening its balance sheet. Analysts at Investec have forecast adjusted year-on-year EPS growth of 31 per cent in FY2016.
Outsiders
Management at Aggreko has forecast full-year pre-tax profit of £250m and £270m in FY2015, down from £289m in the previous year. While the group's restructuring plan is encouraging, it will still be some time before the outcome is known. With commodity prices still very weak as we enter 2016 and concerns of an emerging markets slowdown, we think the shares could fall further still.
