FTSE 350 Review: Business services stocks shrug off economy’s woes

Our note last year that business services companies “tend to be bound to the performance of other sectors” has certainly played out over the past 12 months, as valuations have reflected disparate outcomes across the economy – with rising interest rates the chief determinant.

The higher cost of capital is having a marked, albeit belated, impact on the jobs market. The early part of the year always features a flurry of trading updates from the recruiters, a closely watched cohort within business services. Indeed, last time around we noted that fee growth had slowed down, and it's clear the market turned negative on recruiters’ prospects as early as January 2022, a month after the Bank of England started cranking up the base rate.

Both PageGroup (PAGE) and Hays (HAS) duly revealed falling net fee income in their early 2024 updates as “low levels of client and candidate confidence continued to delay time to hire, particularly in permanent recruitment”. There was also a clear shift towards temporary contracts, significant because it suggests that employers are hesitant to make commitments that permanent contracts entail. The OECD – in concert with other intergovernmental organisations — is predicting a "mild slowdown" for the global economy this year, so UK recruiters will need to continue navigating softening job markets in the months ahead, at least until central banks start to reverse the rates cycle. These are global businesses, but few major economies are immune to hiring weakness, so it would be reasonable to assume a further reduction in fee earners during the year.

There are corners of the business services sector that aren’t quite so vulnerable to interest rate movements, although for some companies – such as global information services group Experian (EXPN) – any resilience in the face of rising interest rates looks counter-intuitive, given its exposure to business-to-business and consumer services. Its relative stability could be explained by the sizeable proportion of organic sales growth that is being generated in developing markets. At any rate, the fact that it continues to trade on an elevated forward price/earnings rating points to continued market support.

Global distribution agent Bunzl (BNZL) has seen its own profits sustained partly due to the increased proportion of own-brand sales. Businesses have been swapping out branded lines as consumers have become increasingly price conscious. In this case, a diversified and expanding global footprint means that the group is less exposed to regional downturns, and free cash flows have been building as swollen inventories linked to the pandemic unwind.

A seasoned sector constituent such as Rentokil Initial (RTO) should be a solid defensive option given that demand for pest control services doesn’t tend to be price-elastic. And yet the group’s share price headed south in October after revenue growth slowed through the third quarter and new business wins trailed away in its particular area of expansionary focus, North America. That was partly due to householders moving less frequently due to spiralling borrowing costs.

Futures markets anticipate that developed market central banks likely will start to trim base rates over the remainder of this year and into next, not withstanding the recent datapoints showing inflation hasn't gone away just yet. But the impact of this shift on business services companies will not be linear, given the variety of businesses that have sprung up from corporations decentralising business functions over time. This has arguably rendered the sector the preserve of stockpickers, so without underestimating the influence of macro effects, it would be unrealistic to make any blanket assumptions on performance.