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Opportunities arise in support sector

THE UK stock market has been relatively strong in the nine days of trading in 2012 despite words of warning from many commentators heeding the multitude of risks to continued economic growth.

THE UK stock market has been relatively strong in the nine days of trading in 2012 despite words of warning from many commentators heeding the multitude of risks to continued economic growth.

These risks are very real, although none may materialise and other unheralded threats will emerge.

Against this backdrop investors will be focusing perhaps more than usual on the range of asset classes within their portfolios, in addition to the geographic spread and the range of industrial sectors.

One of the most diverse sectors in the UK equity market is the support services sector, which contains companies such as Aggreko, G4S and Capita and covers a wide range of operations from Government outsourcing to industrials and cyclical subsectors.

Of the Government outsourcing companies perhaps the best known is FTSE 100 constituent G4S, which specialises in security.

However, other companies in this market are Serco Group and Capita, also in the FTSE.

The contracts awarded by governments and local authorities tend to be relatively long-term and the earnings are considered to be secure – governments and local authorities are unlikely to go bust.

This means that investors can view the future earnings of these companies with greater clarity as their order books will contain revenue stretching several years ahead generated through these long-term contracts.

Due to this, shares in Government outsourcing companies have tended to attract a premium.

However, 2011 was a bad year for companies in this subsector as there were delays in the awarding of many contracts and the turmoil in the Middle East, previously viewed as a region of great opportunity, also had a detrimental effect. As a result, much of the premium typically attached to shares in the subsector has disappeared.

The Industrials subsector contains Aggreko, the international power rental business, and Intertek Group, the quality and safety company, which are both FTSE constituents.

Industrial support services groups enjoyed a successful 2011 and many companies within the subsector grew their earnings ahead of forecasts, with the Japanese tsunami and development of the Olympic site in London a strong source of revenue for Aggreko in particular.

Share price valuations are currently higher than those of the Government outsourcing companies in terms of annual earnings, reversing the usual pricing norm. The cyclical subsector’s two largest companies are Experian, the credit checking business, and Wolseley, the trade distributor of plumbing and heating equipment.

The improvement in US economic data from the late summer led to a strong end to 2011 for the subsector.

It is likely that investors will weigh the risks to continued economic growth particularly closely when considering investing in these companies though.

Support services is an extremely diverse industrial sector and many companies within it have reasonably clear earnings streams over the coming years. However, before investing personal circumstances and attitude to investment risk should be considered and advice sought.

Fergus.westwood@brewin.co.uk

 

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