Business Services - The Shift Is On - Zacks Analyst Interviews

By
A A A

To Begin With

Business services sector is comprised of companies that provide ancillary services to other players in the market. Hence, the core business of one company can be a business service for another.

Operating efficiencies demand companies to focus on functions and activities that are close to their core competence. This not only helps them to reap the benefits of economies of scale in those core functions, but also improves their competitive positioning. Importantly, this dynamic opens the door to business services companies to provide those services.

The business service sector is highly fragmented, with no single service provider enjoying market dominance. As per business reports, the top 50 companies of the sector contribute less than 25% to the overall revenue of this sector. However, given its unique nature,

Zacks has classified the group as one of 16 sectors (the S&P's official GIC classification has only 10 sectors where business services are grouped within the 'Industrials' sector). The Business Services sector accounts for 3.1% of the S&P 500 index's total market capitalization and is expected to bring in roughly 2.4% of the index's total earnings this year.

Stand-Alone Zacks Sector

This industry covers an array of services that include marketing, consulting, staffing, security, telecommunications, Internet services, logistics and waste handling. In its expanded sense, the U.S. business services sector generates consolidated yearly revenue of about $620 billion, though many companies mentioned below do not strictly fall within the generally accepted definition of the industry.

Within the Zacks Industry classification, we have divided the business world into 16 sectors comprising 60 industries (at the medium or M-level) and 260 industries at the expanded or X-level. We rank all 260 X-level industries in the 16 sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available in the Zacks Industry Rank page.

The way to align the ranking and outlook from the complete list of Zacks Industry Rank for the 260 industries is by dividing it into positive, neutral and negative categories depending on the Zacks Rank. The outlook for the top one-third of the list (Rank of #88 and lower) is positive, while the outlook for the bottom one-third (Rank #177 and higher) is negative. The outlook of the middle one-third of the list (Rank of #89 to #176) is therefore neutral.

Please note that the Zacks Rank for stocks, which is at the core of our Industry Rank, has an impressive track record, verified by outside auditors, to foretell stock prices, in particular over the short term (1 to 3 months). We have 7 X-level industries within the Business Services sector, namely, Auction/Valuation Services, Business Information Services, Business Services, Consulting, Financial Transaction Services, Outsourcing, Staffing and Waste Removal Services.

Waste Removal as well as Financial Transaction Services at Zacks Industry Rank #37 and Staffing #64 fall in the upper 1/3 of all Zacks industries and have a positive outlook. Outsourcing and Business Information Services at #111 and Business Services at #170 are positioned in the mid 1/3 of all Zacks industries and have a neutral outlook. Consulting at #191 falls to the bottom 1/3 with a clear negative outlook. This distribution of industry ranks within the sector shows that the overall bias is neutral to negative.

Earnings Review

Earnings for the business sector grew 9.7% in the first quarter, faring better than the overall 1.3% growth for the S&P 500. The earnings growth pace moved north compared with 8.8% growth in the previous quarter. Revenues showed an improvement of 5.0%, faring much better than the S&P 500's year-over-year average of 2.7%. Revenue growth also improved sequentially.

About 9.1% of the companies have already reported their second quarter earnings. Earnings improved 7.2%, lagging the overall 11.1% growth for the S&P 500. Revenues improved 14.0%, faring better than the S&P 500's year-over-year average of 6.6%.

With majority of the companies yet to report, the sector is expected to put up double-digit growth rates in second quarter. Earnings are expected to grow 10.4% on revenue growth of 7.9%.

In terms of surprises, till now the sector's performance is softer than the broader market, with 50% of Business Services companies beating earnings expectations compared with the 'beat ratio' of 56.5% for the S&P 500.

Looking ahead, 2014 and 2015 earnings are expected to improve 12.7% and 13.3% respectively. This compares favorably with 7.2% and 11.7% for the broader market. Revenue growth is expected at 5.0% for 2014 and 6.3% for 2015 for the sector compared with a minimal improvement of 0.8% and 3.8% for the respective years for the S&P 500.

For a detailed look at the earnings outlook for the Business Services and other sectors, please check our weekly Earnings Trends report.

Stocks for Building Your Portfolio

Considering Zacks Rank, share prices, earnings surprise history and future growth prospects, we think the following two stocks are worth taking a close look.

Avis Budget Group, Inc. ( CAR ): This provider of vehicle rental services through a network of car and truck rental locations in the U.S., Canada, Australia, New Zealand, Latin America, the Caribbean, and parts of Asia, delivered positive earnings in the last four quarters in with an average beat of almost 30.79%. The stock gained about 53% year to date, hitting its 52-week high of $61.95 on Jul 3.

With initiatives such as changing business mix and focus on accelerating profitable unit- bearing fruit, both volume and price continue to witness an uptrend. Its inorganic story looks impressive with several acquisitions. The company also remains focused on controlling costs. Its share buyback program is on track and continues to aid its bottom line, thereby enhancing shareholders' returns.

Our model projects earnings growth of about 26.5% for Avis Budget over the long term.

ExamWorks Group, Inc. ( EXAM ): This provider of independent medical examinations (IMEs), peer and bill reviews, Medicare compliance, and other related services delivered positive earnings in the last four quarters in with an average beat of almost 40.72%. Share prices also gained about 21% year to date. Given the prospect of the company, we find more potential left. Our model projects earnings to grow about 20% over the long term.

The company continues to benefit from superior organic growth, technology solutions that drive operating leverage and expanding margins, and considerable cash flow. Its compelling inorganic growth story is also expected to boost the performance level.

Both Avis Budget and ExamWorks sport a Zacks Rank #1 (Strong Buy).

What Keeps Business Service Rolling

The most important feature of this industry is that it is labor intensive - creating employment - given the nature of intangible products offered by the service sector. Business reports indicate that the two most populated countries, China and India, are together expected to create 300 million employment opportunities in the global job market by 2030. According to International Monetary Fund, unemployment rate in the U.S. is expected to decline going forward - from 6.7% in 2013 to 6.2% in 2014 and 5.9% in 2015.

The industry offers specialized services based on the latest technologies. With specialized services, these providers reduce the operational cost and in turn the overall cost of companies, thereby benefiting margins. Notably, an increased number of companies opting for such specialized services would expand volumes for service providers. This would eventually lead to services at lower costs and a further reduction in costs for companies.

The industry offers global reach, helping the company widen its customer base and maintain a better retention ratio. It also opens the door to international trade.

Though the first quarter witnessed a slowdown, the International Monetary Fund estimates that U.S. GDP growth will improve to 2% in 2014 and accelerate to 3% in 2015 from 1.9% in 2013. This opens more opportunities for the service sector.

Headwinds

A major challenge faced by this industry is spending by companies to avail of services from business service providers. This, in turn, is directly tied to the health of the economy.

As this industry provides specialized services, it involves continuous spending on research and development as well as training, maintaining skilled workforce. While continuous research and development help it acclimatize or adapt to new services to account for the ongoing development, training and maintaining skilled workforce limit high turnover rate.

Increasing competition also threatens this industry. As the main business of one company can be a business service for another, maintaining or increasing market share can pose risks to business service providers.

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. The business service space has seen a flurry of acquisitions so far this year.

In February, Avis Budget Group closed the $30 million tuck-in acquisition of Budget Licensee in Edmonton. The takeover has expanded the company's international reach and helped it to tap opportunities in the oil and gas industry.

ExamWorks made three acquisitions in the first half - Ability Services Network, Inc. and its subsidiary MedAllocators, Inc. in June, Solomon Associates, Inc. in May and Gould & Lamb in February. While Ability Services Network will offer economies of scale in the highly fragmented Medicare compliance market, Solomon Associates will widen its footprint in Pennsylvania.

Corporate Resource Services, Inc. ( CSSR ), a diversified technology, staffing, recruiting and consulting services firm, acquired Nationwide Screening Services in March following the Alar Staffing and Staff Management Group buyouts in February.

Global education leader Houghton Mifflin Harcourt ( HMHC ) made a couple of buyouts in May.  One was an online, personalized learning environment entitled Curiosityville and the other was Channel One News, which helped it to expand digital content offering and production capabilities.

RPX Corporation ( RPXC ), the leading provider of patent risk management solutions, acquired PatentFreedom, the first provider of data, intelligence and consulting on non-practicing entities (NPEs) in June.

Vaid Corp. ( VVI ) acquired West Glacier Motel & Cabins, the Apgar Village Lodge and its related land, food and beverage services and retail operations.

To Conclude

A dearth of skilled labor in the business services sector can impact 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 for it. The expected annual compounded growth rate for this sector is 4% from 2010 to 2015.

The sector might also attract new investors as nearly one-third of the companies under our coverage in the business service industry shares profits with their shareholders via dividend payments. Notably, dividend payments help in retaining stockholders' confidence in a company. Also, companies undertake share repurchases to enhance shareholders value.

With an ever-increasing population and economic turmoil being a constant drag, generating employment is a burning issue. This sector, being labor intensive, involves lower capital investments and confidently addresses this problem. Emerging economies such as India and China are also becoming important destinations for the business service sectors. On the flip side, these economies pose challenges to employment growth in developed economies.

Nevertheless, we can safely say that despite all the hurdles, this industry is crucial for business operations.


Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

RPX CORP (RPXC): Free Stock Analysis Report

HOUGHTON MIFFLN (HMHC): Free Stock Analysis Report

EXAMWORKS GROUP (EXAM): Free Stock Analysis Report

AVIS BUDGET GRP (CAR): Free Stock Analysis Report

To read this article on Zacks.com click here.

Zacks Investment Research




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 , Stocks

Referenced Stocks: RPXC , HMHC , EXAM , CAR

Zacks.com

Zacks.com

More from Zacks.com:

Related Videos

Stocks

Referenced

Most Active by Volume

33,110,376
  • $113.99 ▲ 1.77%
25,034,179
    $17.98 unch
24,486,872
  • $7.41 ▲ 2.07%
20,864,535
  • $7.39 ▼ 2.76%
18,600,501
  • $8.30 ▼ 0.36%
17,530,211
  • $8.14 ▲ 3.17%
17,299,208
  • $93.79 ▲ 2.74%
14,669,760
  • $25.78 ▼ 0.19%
As of 12/26/2014, 04:15 PM


Find a Credit Card

Select a credit card product by:
Select an offer:
Search
Data Provided by BankRate.com