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Business Services Stocks to Gain from Improving Employment

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Business services’ stocks have lately delivered strong performances, with the players enlisted in the S&P 500 (one of the 16 Zacks sectors) gaining more than the index both in the year-to-date and the trailing 12-month periods. In this write-up, we have highlighted the sector’s positives in order to appreciate its recent outperformance and give an outlook for the near future.

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 Bureau of Labor Statistics, the unemployment rate in Jan 2017 remained almost unchanged at 4.8% with non-farm payroll employment increasing by a little more than 0.2 million in the month. Jobs were added in retail trade, construction and financial activities.

Ushering in more good news for the service sector, President Trump has hinted at creating more jobs and employment. The new President has shown discontent about moving jobs outside the U.S. during his election campaign. Trump said, "I just want to let all of the other companies know that we're going to do great things for business. There's no reason for them to leave anymore.”

Beyond the U.S., the outlook for many other key growth markets also remains favorable. 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 instead of products to others. This, in turn, frees them from producing goods that would otherwise need manufacturing facilities. As a result, business services do not have inventory or stock and hence, do not involve costs for later use.

Moreover, services can be tailor-made for any situation. This is not possible or feasible for something tangible.

Global Reach:Companies can reach 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 alongside opening the door to international trade.

A key development in this regard has been noticed in the banking space. Online banking for transfer and collection of money from anywhere in the world, mobile money transfer and ATMs are fast gaining traction. The Western Union Company (WU - Free Report) and MoneyGram International Inc. (MGI - Free Report) are among the stalwarts that are continuously offering cutting-edge services via electronic channels to ensure smooth fund transfers. Fund transferors are forming alliances with banks and mobile operators to launch their services.

Mobile payment is gaining popularity owing to its convenience and round-the-clock accessibility. This channel will see a faster adoption rate than any other electronic channel. Western Union’s Vigo and OrlandiValuta branded services are 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 U.S. The company plans to add retail locations and more account-based options. MoneyGram has 350,000 agent locations across 200 countries and territories.

A large portion of the world market remains underpenetrated. With the strategic introduction of money-transfer in these markets, service providers should enjoy ample business opportunities.

In addition, a continued shift toward electronic forms of payment from paper-based forms has created a dependence on plastic money or debit and credit cards. This has encouraged card processors to ramp up their growth profile. Visa Inc. (V - Free Report) and MasterCard Inc. (MA - Free Report) are among the primes that are well placed 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 companies that opt for services that would otherwise be far more expensive.

With specialized services, these providers reduce operational cost and in turn, lower the overall cost of companies. Notably, a higher number of companies opting for such specialized services would increase volumes for 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 BS margins have consistently grown in the trailing four quarters, and will likely retain the momentum in the next three quarters too. Importantly, BS margin expansion is better than that of the S&P 500 Index.

Gaining from Stronger Currencies: Companies in a country with a stronger currency can gain if they get their jobs or services from countries that have comparatively weaker currencies. This is because the company will have to spend less and thus gain from currency translation. In turn, this will lower the cost of its goods or services and favor margin expansion.

Specialized Service:The industry offers specialized services based on the latest technologies. This is crucial for security and consulting services. To safeguard data, companies are compelled to engage security service providers, which need the latest and most efficient technologies to persuade 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 rapidly 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 by trial and error. Hence, this service sector looks promising owing to its indispensability to companies that are struggling to survive in a competitive market.

Consolidations: Mergers and acquisitions play a vital role in not only strengthening a company’s foothold with more market share but also in helping it gain a competitive edge. Also, the inorganic route helps to insulate the industry from macro headwinds to a great extent. Since the sector is highly fragmented, a wave of mergers and consolidations is quite likely.

In Jan 2017, WNS (Holdings) Limited (WNS - Free Report) , a leading provider of global Business Process Management (BPM) services, agreed to acquire leading provider of strategic procurement BPM solutions, Denali Sourcing Services (Denali), to add strategic procurement capability to its existing Finance and Accounting solutions.

In Dec 2016, Avis Budget Group Inc. (CAR - Free Report) acquired France Cars to ramp up its presence in the French vehicle rental market. Viad Corp. (VVI - Free Report) acquired FlyOver Canada business to expand its Travel & Recreation Group.

Bottom Line

The economy is now improving and population continues to increase in the U.S. This sector, being labor intensive, involves lower capital investments and confidently addresses the issue. While emerging nations are becoming important destinations for business services, these economies pose challenges to employment growth in developed economies.

Given the inherent strengths, the business service sector has enough steam left to drive the engine toward growth.

Investors can look for Liberty Tax, Inc. TAX, Core-Mark Holding Company, Inc. (CORE - Free Report) and WNS (Holdings) Ltd carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Check out our latest Business Services Outlook here for more details from an earnings perspective, and how the trend is looking for this sector from now onward.

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