FTSE 350 Review: Business services braced for slowdown

Recruiters are an obvious example. PageGroup (PAGE) and Hays (HAS) have seen the confidence of their clients falter over recent months, and fee growth has slowed down considerably as a result. To some extent, their vulnerability is already embedded in their respective valuations; shares in PageGroup and Hays both fell in 2022 as recession fears mounted. However, we worry that it might still be too soon to buy the dip. 

Distributors have also had a lot on their plate when it comes to end markets. Analysts are worried that RS Group (RS1), for example – which supplies electronic products such as switches, wires and sensors – will experience a fall in demand given the widespread manufacturing slowdown and the uncertain semiconductor market. So far, however, distributors have held up remarkably well. RS Group, Bunzl (BNZL) and Diploma (DPLM) all generated impressive amounts of cash last year, despite big working capital requirements caused by supply chain hold-ups. 

Analysts are now hopeful that small acquisitions in 2023 will bolster growth (the fragmented nature of the distribution industry means it is well suited to accretive M&A). Growth is unlikely to knock investors’ socks off, but we’re still cheerful about the long-term prospects. 

Other business services groups have escaped the UK’s economic gloom by looking further afield – namely, to North America. This is going rather well for plant and equipment hire company Ashtead (AHT), which is continuing its push across the US and enjoying double-digit profit growth. The group has been unfazed by fears of a construction slowdown, chief executive Brendan Horgan telling analysts in December that conditions were “as favourable for our business as I’ve ever witnessed”. 

One thing investors should keep an eye on in this sector, however, is debt. Ashtead’s net debt rose by $1.25bn (£1bn) to $8.4bn between May and October 2022, after the group acquired 27 companies in the space of six months. This pushed its leverage up to 1.6 times, which shouldn’t be a problem assuming it keeps up the profit momentum. However, its fate is entwined with the state of the US property market, and that context shouldn’t be dismissed out of hand. 

Rentokil (RTO) is another company that sets off debt alarm bells. Last summer, net debt was equal to 2.2 times cash profits, at £1.4bn. As of December 2022 – following the acquisition of US extermination giant Terminix – net debt had risen to between £3.3bn and £3.4bn. Clearly, profits will also be higher after the acquisition, but that’s still a lot of borrowing to contend with, and pest control sales in North America were slow in the latest quarterly update. What's more, Rentokil is no longer being buoyed by the scramble for disinfectant.

Nevertheless, there’s little doubt that demand for its services will be robust in the long term. Pest control is hardly discretionary and – alarmingly for the rest of us – analysts at Jefferies have identified “structural tailwinds”. The same can’t be said for IWG Group (IWG), the serviced office space provider. As well as huge lease liabilities, IWG is facing a demand slump that’s unlikely to improve during an economic downturn. 

For all the challenges facing business services, however, it is worth noting that this category is smaller than it was in 2022 because both Homeserve and Clipper Logistics have been acquired. While short-term headwinds can be offputting, therefore, there’s clearly value to be found.