Sector in Focus – UK Support Services
The UK’s support service sector is a diverse group of companies that support the economy through the provision of business critical and specialist activities, and other services that benefit from their scalability as outsourced functions. These activities include professional and technical skills, distribution and supply management, security, safety, and recruitment, to name a few, but the list goes on.
The sector is typically considered more defensive as non-core business functions find themselves less at the whim of short-term shifts in demand while companies within the sector lend themselves towards securing revenue through longer-term contracts. Often, with less asset rich balance sheets and more flexible costs, support sector business tends to be more cash heavy and income producing. The broad range of business, however, makes it difficult to paint the whole industry with the same brush.
Over one year the sector is up a steady 9.18%, a median performance figure, broadly in line with the overall UK equity market. Trailing P/Es average 23.7, in line the market, having reduced over the last three years and now much more in line with the long-term average. UK Service PMIs have been falling of late and trail those of other developed economies but remain in overall positive territory.
Brexit will evidently impose itself at some point. Services contribute in the region of two fifths to UK export revenues and international trade in services may rely on factors such as staff mobility and benefit from openness and integration. Few existing free-trade agreements cover services in detail or provide the openness of the EU single market.
More domestically, a government review of employment practices signals a move towards revised legislation that protects the rights of the more vulnerable members of the workforce without adding unnecessary red tape. Openness to employment flexibility should support companies looking to harness the UK’s contingent labour market.
Babcock, provider of highly skilled engineering support, has begun the year well with 76% of revenue already secured for the current financial year and 52% for the next. The order book is stable at £19 billion with £10.5 billion in the pipeline and a rebid rate of over 90%. The numbers support the steady growth story over the short and medium term.
Net debt continues to reduce further from £1.17 billion reported in the annual report, with an expected debt to EBITDA ratio of 1.6 by the end of the current financial year. This figure has been decreasing steadily from 2.2 in 2015 following significant revenue expansion. Revenues were up 7.7%, year on year, while operating return on revenue remained steady in the region of 11%. However, operating margins within non-marine, aviation and nuclear activities may be starting to feel the squeeze after falling for two consecutive years.
Recent contract wins include a £500m contract to operate a fleet of medical support aircraft across Norway, a £340m Ministry of Defence contract for Marine Systems Support Partner, and further work for Britain’s Nuclear Decommissioning Authority.
Earlier in the year, the company had prematurely ended its nuclear reactor clean-up contract after the Government were deemed to have mishandled the procurement process, reducing the company’s pipeline by £800m.
Capita, one of Britain’s largest outsourcing and professional service providers, has recently cut last year’s profit by almost a third after restating its financials under new accounting rules. Revenue also fell from £4.6 billion to £4.4 billion.
The group announced a series of profit warnings towards the end of last year and saw its share price collapse by a third. It has since sold its asset services businesses in order to strengthen the balance sheet and return to profitable, sustainable growth.
Andy Parker, Capita’s chief executive, announced that he would step down in March, a day after the company was demoted from the FTSE 100 to the FTSE 250, and Capita is yet to announce a suitable replacement. He left the company last week, with Nick Greatorex appointed as interim CEO remaining so until a successor can be found.
In addition to earnings woes, the company is also facing pension troubles as it aims to close its defined benefit pension scheme, affecting 3% of its workforce. In some extreme cases, employees may lose up to 70% of their retirement income. Poor navigation of this minefield could result in industrial action.
Compass, the world’s largest catering firm, paid a special dividend of £1 billion in July after being unable to identify suitable opportunities after a first half in which revenues and profits soared. Six-month revenue rose by 20% to £11.5 billion, bolstered by favourable currency moves, with strongest growth in the US. Operating profit rose 5.2% to £894m reinforced by improving operating margins, signalling efficiency gains.
The special dividend equates to 61p per share and the group will take on some debt to help finance it, with the group targeting a more sensible balance sheet leverage of 1.5 times earnings (EBITDA) from 0.9 previously reported. Compass will also raise its interim dividend by 5.7%.
The company is light on fixed assets and the main costs are its half a million strong workforce and the purchasing food and drink, both of which can be adjusted with changes in demand. Almost half of its operations are in healthcare, education and defence sectors and it has historically returned over half of all profits to shareholders.