Business Services Stock Outlook - Dec 2012 - Industry Outlook

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In today's world, companies strive to remain focused on functions and activities that are close to their core competence and where they enjoy competitive advantages. But they still need to perform a host of other functions in today's complex marketplace. This need opens the door for providers of business services.

Business services can be defined as ancillary services provided by companies to other players in the market. It can also be called a tertiary sector. Hence, the main business of one company can be a business service for another company. But given its unique nature, we at Zacks have classified the group as one of sixteen sectors (the S&P has only 10 sectors and business services is part of its 'Industrials' sector).

The business service sector is highly fragmented, with no single service provider boasting dominant market share to rule the industry. As per business reports, the top 50 companies of the sector contribute to less than 25% of the overall revenue of the business service sector.

The business services industry comprises a large number of businesses. The industry's array of diverse services include marketing, consulting, staffing, security, telecommunications, internet services, logistics and waste handling, among many others. In its expanded sense, the US business services sector generates consolidated yearly revenue of about $620 billion, though many companies mentioned below do not strictly fall into the generally accepted definition of the industry.

Industries in the Business Service Sector

Advertising & Market Services and Direct Marketing plays a vital role in informing consumers about new products, eventually helping the producers to better penetrate the markets. The Interpublic Group of Companies, Inc. ( IPG ), Omnicom Group Inc. ( OMC ), Valassis Communications Inc. ( VCI ), Harte-Hanks Inc. ( HHS ) and Vertis are important players in this industry.

Consulting Service providers offer expert advice in a given field for smoother functioning of the companies. Major companies in this arena include Accenture plc ( ACN ), Bain, Booz Allen, Deloitte Consulting (an affiliate of Deloitte Touche Tohmatsu), and IBM Global Services ( IBM ).

The Staffing business helps companies identify and recruit the right person for the right job. This sector is dominated by Insperity Inc. ( NSP ), Kelly Services Inc. ( KELYB ), ManpowerGroup ( MAN ), ADP TotalSource and the U.S. operations of Adecco.

Internet Service Providers and Telecommunication Services act as a bridge to connect knowledge, information and personnel across the globe. This sector is ruled by AOL Inc. ( AOL ), AT&T Inc. ( T ), Verizon Communications Inc. ( VZ ) and Comcast Corporation ( CMCSA ).

Surveillance, Investigation & Security Consulting Services providers offer specialized security services and this sector is dominated by FTI Consulting ( FCN ) and Kroll.

Waste Management service providers offer services that include collection, transport, processing, recycling, disposing and monitoring of waste. Waste Management Inc. ( WM ), Republic Services Inc. ( RSG ) and Waste Connections Inc. ( WCN ) are the major players in this arena.

The U.S. and Europe are the largest markets for the business service sector. Some of the dominant players beyond the U.S. boundary include: waste and remediation services provider Veolia Environnement (VE) (France), facilities support services provider Serco Group (UK), staffing services provider Adecco ( Switzerland ), travel agency service TUI Travel (UK), and security services provider G4S (UK). Other big names in the field are Rentokil Initial (UK); and ISS (Denmark).

Nevertheless, the emerging economies such as India and China are also becoming important destinations for the business service sectors.

OPPORTUNITIES

Labor Intensive: Given the nature of intangible products offered by the service sector, it is a labor intensive industry. Labor, both skilled and unskilled, is an essential part for smooth functioning of this sector. Being a labor-intensive sector, it offers immense employment opportunities.

Global Reach: Companies can reach its consumers or prospective buyers across the globe when Advertising & Market Services and Direct Marketers act on behalf of them in informing consumers about new products or added features of existing products. Thus, these service providers help in widening a company's customer base and/or maintaining better retention ratio.

Further, technology, or specifically Internet, enables any producer to sell their products globally from any part of the world. Thus, companies enjoy a wider marketplace. Here comes the importance of Catalog & Mail Order Houses like eBay Inc. ( EBAY ) or Amazon.com Inc. ( AMZN ) among others, through whom customers at one end of the globe can get any product shipped to them from any other end of the globe.

Cost Effective: All business operators prefer to minimize costs of operation and maximize margins. This sector offers cost effectiveness to the companies that opt for their services. Companies will have to incur higher costs if a company employs the services by themselves and does not take the help of the service providers.

The service providers specialize in particular services and reduce the operational cost of a company, eventually helping companies to limit overall costs. Notably, an increased number of companies opting for such specialized services would increase the volumes for the service providers. As a result, they can offer services at a lower cost, which in turn will further lower the cost for the companies.

Specialized Service: The industry offers specialized services that come with latest technologies. This is very evident for the security and consulting services. To safeguard data, companies are compelled to engage security service providers. The security service providers need to have the latest and most efficient technologies in place to persuade its clients and win business contracts.

Also, with increased number of mergers and acquisitions across the globe, the prospects for legal service providers look good. Consulting services is another wing of this industry that is gaining traction at a higher pace these days.

With complexities in business on the rise, companies are opting for expert advices before entering into any new venture rather than having hiccups once already into it. Hence, this service sector also looks promising as their services are becoming an indispensable part for companies that are fighting to survive in the competitive market.

CHALLENGES

Growth Tied to Health of Economy: One of the major factors that could impact the growth of the service sector is the overall health of the economy. The companies in the business service sector derive revenue by providing essential services to other companies. Spending by companies to avail services might reduce drastically if the pace of economic growth is slower than the expected level. This would naturally reduce the business of the service providers and affect their fundamentals.

Requires Continuous Spending for Research and Development: Most importantly, the consulting service providers need to be updated with the latest technologies that require continuous spending on research and development. Performance of these providers can be hampered if it does not acclimatize and/or widen its services with the ongoing developments.

Training, Maintaining Skilled Workforce: Since skilled workers are always in high demand, there remains a possibility of high turnover rate within the sector. Training of unskilled workers or taking in new skilled workers increases operational costs, thereby affecting margins. This sector needs to have more skilled workforce to take advantages of the technology that is developing almost everyday.

Competition: Maintaining the market share or increasing the same remains a challenge for business service providers. As discussed earlier, the main business of one company can be a business service for another company; hence target customers for both may be the same at times. Therefore, a business service provider is always required to be adequately equipped to win over customer demand. While larger providers bank on the broader variety of their service offerings and can effectively take up difficult ventures, the relatively smaller players compete in the industry backed by their specialized services.

Earnings Review

The earnings picture for the Business Services group is better than broader market. In the just-completed third quarter reporting season, total earnings for the sector were up 5.9% from the same period last year, which compares to no growth for the S&P 500. Total revenues for the sector were up 0.6% in the quarter, compared to the 0.7% decline for the S&P 500 as well.

In terms of surprises, the sector's performance was weaker than the broader market, with only 57.9% of Business Services companies beating earnings expectations, compared to the 'beat ratio' of 62.8% for S&P 500. The variance is far more pronounced in the fourth quarter, when total earnings for the sector are expected to be up 15.3% from the same period last year, while total earnings for the S&P 500 would be up only 2.3%.

Zacks Industry Rank

The Zacks Industry Rank, which derives its predictive power from the time-tested Zacks Rank, helps us identify the industries that are expected outperform others. The top 1/3rd of the Zacks Industry Rank qualify as industries with 'Good' prospects, the bottom 1/3rd have 'Bad' prospects, and middle 1/3rd as 'Neutral.' Most of the constituent 'industries' in the business services sector fall in the top 1/3rd of the list.

For example, the Consulting industry is currently at # 33 which puts in the top 15% of the industries. Of the 18 companies in the Consulting industry, 8 have Zacks #1 Rank (Strong Buy) or Zacks #2 Rank (Buy), while only two have Zacks #5 Rank (Strong Sell) or Zacks #4 Rank (Sell). Companies like CBIZ ( CBIZ ), CoreLogic ( CLGC ) and CRA International ( CRAI ) all have Zacks #2 Rank (Buy). The Financial Transaction Services industry, with players like Visa ( V ) and Mastercard ( MA ), is currently at 54 or in the top 22% of industries.

To Conclude

A dearth of skilled labor in the business service sectors can have an impact on future growth possibilities. Non-availability of quality workforce at a reasonable rate might increase overall operational costs.

However, due to the highly fragmented nature of the industry, it is difficult to set a distinct trend or predict a concrete future of the industry. The industry is expected to grow at an annual compounded rate of 4% from 2010 to 2015.

With population growing at an accelerated pace and economic turmoil being a constant drag of late, generating employment is a burning issue. This sector, being labor intensive, involves lower capital investments and confidently addresses this problem. Thus, we can safely say this industry is essential to business operations going forward, despite the hurdles.



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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Business , Investing Ideas , Stocks

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