We examine four key companies in the Support Services sector
Sector in focus : Support Services
The support service sector covers a wide variety of businesses but one of the most high profile areas in recent years has been outsourcing. It has been a growing trend in the commercial world for many years although its image was badly tarnished by the demise of one of the largest companies involved in the practice, Carillion, earlier this year. It came as a particular shock to investors seeking income, as the company had been a good dividend payer, but there had been clear signs of trouble for some time.
Carillion was not alone as several other companies had run into difficulties for various reasons, making unrealistically low bids for large government contracts and running up unsustainable debt levels. Interserve, Mitie and Serco have all experienced difficulties in recent years, but all have survived so far.
Capita is also among that group, but its management appear to have learned some of the lessons from the Carillion collapse. Part of the issue with Carillion was that the end came very quickly and seemed to catch a lot of people unawares. At the end of January the new CEO of Capita revealed that he had carried out a thorough review and provided a long and very honest list of the problems he was tackling - underinvestment, a short term focus, too many acquisitions and a lack of operational discipline and financial flexibility. The profit warning that came with that was no great surprise and, along with talk of a rights issue, a 35% drop in the shares was a reflection of the market’s growing concern about the sector.
It must be said that the CEO did win some favourable comments from analysts who felt he had at least made great efforts to fully open with the market. When the company subsequently announced a £700m fully underwritten rights issue in April, to reduce its debts and provide more capital, along with plans to simplify the business, the share rose as investors felt reassured that the company was taking extensive action to address the main problems. They also noted that the full-year results showed a 34% rise in underlying profits.
Having said all that there’s still much uncertainty around the business and many investors are nursing large losses. The company is unlikely to pay a dividend for some time so income investors will need to look elsewhere.
The support services sector covers a wide variety of companies and there are better options for investors among those with exposure to the US construction sector. One of our favourites is Ashtead, an equipment rental group which generates most of its revenue in North America and which has enjoyed good growth for some time.
The company participated in the clean-up following the devastating hurricanes in the Caribbean last year and also benefited from the weakness of sterling. A third quarter update in March carried an upbeat tone as the company confirmed that the strength of its end markets had led it to continue to invest in further equipment. Better still for investors is that a £1bn share buyback scheme has been launched which should also support the shares. With a dividend yield of only 1.8% this is not for income-seekers and much more suitable for growth-orientated investors.
Another company in the sector which is benefiting from the strength of the US housing and construction sectors is Ferguson, formerly Wolseley. The company is a major supplier of plumbing products and building materials but there is still plenty of potential for it to increase its market share in the US. Interim results in March were well received and were accompanied by news of a $4 special dividend and a 10% rise in the dividend. With signs of improvement in US industrial markets along with continued strength in the residential housing market, we still view the stock as a buy for medium risk investors looking for growth.
Ferguson is typical of a number of companies in the sector in that its business activities overlap with the construction industry, especially housebuilding. The medium-sized Morgan Sindall also falls into this category with a range of activities from office fit out, property services and urban regeneration to building affordable housing. The fit out division, which refurbishes and redesigns offices and shops, has been performing especially well in recent times with a 42% rise in operating profit last year. A number of significant contracts were won in 2017 and the company expects the division to maintain its good trading in the current year.
In February the company said its order book had increased by 6% to £3.85bn and it raised the dividend by 29%. Better still was news that prospects for the current financial year were better than the management previously thought. We continue to recommend the shares as a buy for investors seeking a balance of income and growth.
What all of this shows in a roundabout way is that the support services sector, like some others such as Travel & Leisure, is very large and encompasses a wide variety of activities. As such, it is worth breaking it down and investors need to be careful to compare similar companies. The outsourcing part of the sector, including Capita, is clearly out of favour at present with a number of companies experiencing difficulties, but the other companies mentioned above prove that there are good businesses to be found with a bit of searching.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.