FTSE 350: Business services braced for turbulence ahead

As with previous years, the uncertainty caused by Brexit is doing the sector no favours. Recruiters such as Hays (HAS) and PageGroup (PAGE) have been soldiering on in a harsh UK trading environment for some time now, and with the latest data from the Recruitment and Employment Confederation pointing to a lack of candidates at the end of last year, the importance of both groups’ international operations looks set to continue. Europe is a significant market for many business services companies, and a slowdown would put particular pressure on recruiters, who have been investing heavily in the continent.

A slowdown in Europe is also a concern for construction services specialist SIG (SHI). Its UK business has been struggling in recent years, which contributed to its having the worst returns in the sector in 2018, down 36.9 per cent. And things are not looking up. It kicked off 2019 by reporting that conditions in mainland Europe had “slowed materially”.

Beyond this, fears over the global economic outlook also seem to be ramping up. Concerns abound about the future trade relationship between President Trump’s US and China, whether the US economy is due for a correction, and just how messy Britain’s exit from the European Union will be. Global politics is too volatile these days to make easy predictions, but it is safe to say investors should take nothing for granted.

Concerns about markets came to a head in the equity sell-offs that hit the FTSE in October 2018. Business services companies were among the worst hit due to the cyclical nature of many of their business models.

But there may also be deeper issues at play. Consultancy EY has compiled data on profit warnings every quarter since the start of 2013. Support services – which houses the business services sector – has consistently ranked as the sector with the most or second most profit warnings, apart from in the second and third quarters of 2018, when it slipped to fifth, and then rose again to third. This looks like an improvement, but it is important to remember fewer warnings could merely be indicative of lowered expectations.

Mergers and acquisitions are a consistent theme in the business services sector, and 2019 could shape up to be a bumper year. Companies such as Rentokil Initial (RTO) and DCC (DCC) have made dealmaking a significant part of their growth strategy, and with the latter’s £606m windfall from a share placing in September, there is scope for additional spending. Furthermore, Bunzl (BNZL) has become increasingly acquisitive in recent years. And while Diploma’s (DPLM) acquisition spend was lower than expected in 2018, analysts predict this will change as owners of businesses in its target markets become increasingly concerned about difficult trading conditions.