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We have extensively modelled the share price and operational
performance of 10 UK-based mid-cap business services stocks
against more than 500 leading and concurrent indicators. The
outlook for 2009, suggested by our research, is bleaker than the low
end of consensus estimates. Our main concern is that the prospects
of earnings recovery by 2010e, indicated by consensus estimates, is
dramatically over bullish. Using historical average PE multiples
applied in previous recessions to 2010e, points towards
considerable further downside for a large number of players in the
sector; we believe there are however a few exceptions.
It is bad and, very largely, not yet in the price…
Almost every leading indicator with a strong correlation to the operational performance of business
services stocks, or their share prices, looks bleak. Using historical guides and our research on bottoming
trends, we arrive at earnings estimates that are materially below the consensus figures for the sector.
Applying average forward PE multiples of previous recession periods to these estimates shows that much
of our coverage universe is yet to experience further downside.
One exception…our Overweight (V) recommendation
One exception to this bleak assessment of the sector is Serco (TP: 550p) which we rate Overweight (V).
We believe Serco offers structural growth with limited cyclicality at low market-relative multiples. We
are Neutral (V) on Hays (TP: 68p), Sthree (TP: 150p), Rentokil (TP: 43p), Bunzl (TP: 580p) and WS
Atkins (TP: 650p). In all of the rest of the sector, we see absolute downside to share prices and initiate
with Underweight (V) recommendations. HSBC has an absolute price-based recommendation structure.
Serco (OW (V), TP: 550p)
Defensive plays capture the attention of investors at times when risk-averse behaviour is prudent. Serco’s
share price looks well-positioned to benefit from its defensive nature, as the gloom in the market deepens
through the next couple of years. The recent trading update confirms the defensive quality of its earnings,
marked by long-term contracts and the existing order book, which provide visibility to future revenues.
However, the risk perception on the stock has increased following: i) the integration of SI International;
and ii) earnings volatility due to exposure to the US defence market. We believe that this provides
investors with an opportunity to enter the stock. Military spend on support services in the US has seen
structural growth as a percentage of the total and is thus less cyclical than total spend. We also expect the
company to remain relatively unaffected by its withdrawal from Iraq.
Serco traded at an average of 2.4x and a maximum of 3.8x CY3e PE multiples relative to the market
during the recession earlier this decade. By applying these premia on the market multiple of 7.2x to our
core CY 2010e estimates, we derive prices of 527p and 826p, respectively. We select our APV value of
550p, which lies in the multiple suggested range.
Beta rally likely but would need economic indicators to turn
The sector, and especially the more cyclical stocks within it, has historically benefited from a beta rally
during recession; it is possible that this will happen again. However, some broad economic leading
indicators turning positive have historically been the trigger for such a rally. We see little point in trying
to anticipate such indicators turning, not least because a rally in business services has lagged turn.
Reality bites twice… beware of beta rallies
Previous beta rallies, like the one in 2001, show that only later do the underlying markets begin to
improve considerably and stocks that rally frequently give up most (and sometimes all) of the gains made.
Such stocks finally recover when the underlying markets begin to recover and the prospect of earnings
downgrades recedes. This seems likely to be at least 12 months away.
Our estimates and recommendations
We have set our recommendations and target prices on a fundamental view that companies that witness a
severe downturn in their share price and see no recovery in 2010e are the most interesting fundamental
opportunities. Investors should note that our recommendation system is absolute, not sector or market relative.
We have also outlined a reasonably high probability of a strong beta rally in the sector, which however
will fail unless underlying markets for the companies in our coverage universe recover more quickly than
has been the case historically. We thus envisage the possibility of an ‘Underweight(V)’ recommendation
and a ‘short-term buy’ at some point in the future, following an improvement in broad economic lead
indicators such as the OECD GLI.
Summary of our sector views
Distributors
Distributors effectively suffer or enjoy the cyclicality of their clients. Given the current downturn scenario, we
expect them to be affected adversely. Further, we believe the greatest risk for this segment remains deflation,
which can severely cramp margins. We have below consensus numbers (but rate all Underweight (V)) on all
the covered stocks except Bunzl (Neutral (V)). We initiate our coverage on Wolseley with a target price of
250p, Bunzl with 580p, Electrocomponents with 115p and Premier Farnell with 110p.
Staffing
Consensus has modelled bottoming of earnings in 2009e, which suggests a very short downturn by
historical standards. For 2009 to be the trough in earnings, US lead indicators would probably need to
turn around soon. Further, we believe that the underlying businesses turn with a lag to these indicators
ranging from 6-8 months. We have below consensus estimates on Hays, Michael Page and Sthree. We
believe Sthree (Neutral (V), TP: 150p) and Hays (Neutral (V), TP: 68p) offer limited downside risks. We
are Underweight (V) Michael Page (TP: 108p).
BPO and Consultancy
WS Atkins and Serco are less cyclical than most players in the much of the sector. Tax receipt timing and
government spending drive their cycles. This suggests to us that these companies are likely to have
another solid couple of years before their growth slows a little then disappoints. These stocks sit close to
the top of the relative valuation range, and historically, this is normal during cyclical downturns. We
initiate with an Overweight (V) rating on Serco with a target price of 550p and a Neutral (V) rating on
Atkins with a target price of 650p.
目录
Distributors 6
Staffing 12
BPO and consultancy 18
Bad but expect beta rallies 21
Avoiding ‘blow-ups’ 24
Bunzl 28
Electrocomponents 38
Hays 48
Michael Page 58
Premier Farnell 67
Rentokil Initial 76
Serco 85
Sthree 95
Wolseley 105
WS Atkins 115
Disclosure appendix 129
Disclaimer 132
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