6 Things To Know About Business Services Sector

By Zacks Equity Research of Zacks.com

Monday, March 2, 2015 4:38 PM EDT

Stocks in the Business Services sector have been strong performers lately, with the sector in the S&P 500 (one of the 16 Zacks sectors) up more than the index both in the year-to-date and trailing 12-month periods. In this write-up, we spotlight the sector’s positives as a way to appreciate its recent outperformance and also outlook for the coming periods.

These are the key positives associated with the sector:

Labor Intensive: The sector, which offers intangible products, has immense employment opportunities as it requires both skilled and unskilled labor for its smooth functioning. Per the report by the U.S. Bureau of Labor Statistics, monthly job gains in the industry averaged 59,000 in 2014.

In Jan 2015, total nonfarm payroll employment increased by an impressive 257,000. Professional and business services created 39,000 jobs in January in the U.S. Among these the major contributors to job growth were professional and technical services, accounting for 33,000 placements.

The Bureau estimates nonfarm employment to grow 2.1% in 2015 and 1.7% in 2016.

Business reports indicate that the two most populated countries, China and India, are together expected to create 300 million placements in the global job market by 2030.

Free from Inventory: By virtue of the nature of its operations, these companies provide services to others rather than products. This in turn frees them from producing goods which would otherwise have needed manufacturing facilities. As a result, business services companies do not have inventory or stock, which would again involve costs, for later use.

Global Reach: Companies can reach their consumers or prospective buyers across the world when Advertising & Market Services and Direct Marketers act on behalf of these in informing consumers about new products or added features in existing products. Thus, these service providers help in widening a company’s customer base and maintaining a better retention ratio. It also opens the door to international trade.

Western Union (WU - Analyst Report) and MoneyGram International Inc. (MGI -Analyst Report) are among stalwarts, which are continuously working on cutting-edge service offerings via electronic channels to ensure smooth fund transfers. Fund transferors are forming alliances with banks and mobile operators to launch their services.

Mobile payments are gaining popularity owing to their convenience and round-the-clock accessibility. This channel will see a faster adoption rate than any other electronic channel. Western Union with its Vigo and Orlandi Valuta branded services were available through a network of more than 500,000 agent locations in 200 countries and territories and over 100,000 ATMs. Importantly, 90% of those locations are outside the United States. MoneyGram has 350,000 agent locations spread over 200 countries and territories.

A large portion of the world market remains underpenetrated. With the strategic introduction of money transfers in such markets, such service providers can enjoy ample business opportunities.

In addition, a continued shift toward electronic forms of payment from paper-based payment forms has created dependence on plastic money or debit and credit cards. This has encouraged card processors to ramp up their growth profile. Visa Inc. (V -Analyst Report) and MasterCard Inc. (MA - Analyst Report) are among the other stalwarts which are positioned to benefit from the tailwinds riding on their respective fundamental strengths.

Cost Effective: All business operators prefer to minimize cost of operation and maximize margins. This sector offers cost effectiveness to the companies that opt for services which would otherwise be far more expensive.

With specialized services, these providers reduce operational cost and in turn the overall costs of companies. Notably, a higher number of companies opting for such specialized services would increase volumes for the service providers. This would eventually lead to services at lower costs and a further reduction in costs for companies, thereby fueling margin expansion.

Our data shows that margins in the business service sector have continuously expanded in the last four trailing quarters, and will retain the momentum in the next three quarters too. Importantly, margin expansion in business service sector is faring better than that of S&P’s.

Source: Zacks Investment Research

Specialized Service: The industry offers specialized services based on the latest technologies. This is evident for the security and consulting services. To safeguard data, companies are compelled to engage security service providers, which are required to have the latest and most efficient technologies in place to persuade their clients and win business contracts.

Also, with increasing mergers and acquisitions across the globe, the prospects of legal service providers look good. Consulting service is another wing of this industry that is fast gaining traction.

Business complexities are on the rise, and companies are opting for expert advice before entering into any new venture rather than risking losses due to trial and error. Hence, this service sector looks promising owing to its indispensability to companies that are battling to survive in a competitive market.

Consolidations

Mergers and acquisitions play a key role in not only strengthening a company’s foothold by grabbing more market share but also in edging out competition. Though the sector is highly fragmented, we notice consolidations here.

Avis Budget Group, Inc. (CAR - Analyst Report), provider of vehicle rental services, acquired the licensee for the Avis and Budget brands in Norway, Sweden and Denmark.

Iron Mountain’s (IRM - Analyst Report) acquisition of Securit Records Management will help it to expand capacity to provide records management services and emerge as a leading information management solutions provider.

PDI Inc. (PDII - Snapshot Report) acquired RedPath Integrated Pathology, Inc., a molecular diagnostics company to expand its molecular diagnostic portfolio.

Performant Financial Corporation (PFMT - Snapshot Report) agreed to acquire Premier Healthcare Exchange, Inc. to enhance its post-payment audit, proprietary analytics and recovery capabilities.

Bottom Line

The improving U.S. economic outlook provides a favorable backdrop for companies in this space, offsetting to a certain extent the issues faced by the global economy. The long-run outlook for the sector remains very positive given the need for most companies to outsource their non-core functions to operators in this space. This trend should continue both in the U.S. as well as internationally.