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To Begin With

Business services sector can be defined as ancillary services provided by companies 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 scale economies 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).

Stand-Alone Zacks Sector – Zacks Industry Rank

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 that the outlook for the top one-third of the list (Zacks Industry Rank of #88 and lower) is positive, while the outlook for the bottom one-third (Zacks Industry Rank #177 and higher) is negative. The outlook of the middle one-third of the list (Zacks Industry Rank of #88 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.

Outsourcing at Zacks Industry Rank #38, Consulting industry at #36, Auction/Valuation at #46 and Financial Transaction Services industry at #84 currently rank among the top 1/3rd of all Zacks industries and have a positive outlook. Staffing at #93 and Business Services at #105 have a neutral outlook. Business Information Services at #206 and Waste Removal at #218 have clear negative outlook. This distribution of industry ranks within the sector show that the overall bias for the sector is positive to neutral.

Earnings Review

With almost 95% of the companies under the Business Service sector having reported their third quarter results, let’s take a look at how things shaped up for the sector.

Earnings for the business sector grew 8.6% in the third quarter faring better than the overall 4.6% growth for the S&P 500 as a whole. The earnings growth pace, however, moved south compared with 9.9% growth in the second quarter.

Revenues showed an improvement of 3.9% faring much better than the S&P 500’s year-over-year average of 2.9%. Revenue growth also improved sequentially.

In terms of surprises, the sector’s performance was stronger than the broader market, with 84.2% of Business Services companies beating earnings expectations, compared to the ‘beat ratio’ of 65.7% for the S&P 500.

Looking ahead at the fourth quarter, earnings are expected to improve 15.2% compared with 9.5% for the broader market. Revenue growth is expected at 3.6% for the sector compared with a minimal improvement of 0.3% for the S&P 500.

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

Industry Review

Outsourcing: Of the 17 companies in our coverage, surprise from the industry ranged from -56.25% to 300% with an average of about 43%. The highest positive surprise came from StarTek, Inc. (SRT) with Vistaprint N.V. ((VPRT) throwing the biggest negative surprise. For the upcoming quarter, we expect Zacks Ranked #1 Broadridge Financial Solutions, Inc. (BR) to come up with positive earnings surprise with a year-over-year increase of 38.2%.  

Auction/Valuation: Of the 4 companies under this category, Ritchie Bros. Auctioneers Inc. (RBA) came up with the highest surprise of 36.4% while Copart, Inc. (CPRT) delivered the lowest surprise of -20%. Average earnings surprise for the industry was 5.3%. We expect Zacks Ranked #1 Sotheby's (BID) to deliver positive earnings surprise in the upcoming quarter with year-over-year growth of 22.5%.

Consulting: Of the 20 companies in our coverage, surprise from the industry ranged from -11.1% to 200% with an average of about 32%. The highest surprise came from Accretive Health, Inc. (AH), while The Hackett Group, Inc. (HCKT) threw the biggest negative surprise. In the upcoming quarter, we expect Zacks Ranked #1 Stantec Inc. (STN) to come up with positive earnings surprise with a year-over-year increase of 12.4%.  

Financial Transaction Services: Of the 20 companies, Xoom Corp. (XOOM) came up with the highest surprise of 150% while Green Dot Corp. (GDOT) delivered the lowest surprise of -24%. Average earnings surprise for the industry was 14.4%. We expect Zacks Ranked #2 Global Payments Inc. (GPN) to deliver positive earnings surprise in the upcoming quarter with year-over-year growth of 9.6%.  

Staffing: Of the 15 companies in our coverage, surprise from the industry ranged from -18.2% to 600% with an average of about 52%. The highest surprise came from Cross Country Healthcare, Inc. (CCRN) with Resources Connection Inc. (RECN) throwing the biggest negative surprise. In the upcoming quarter, we expect Zacks Ranked #2 CTPartners Executive Search Inc. (CTP) to come up with positive earnings surprise with a year-over-year increase of 500%.  

Business Service: Of the 36 companies enlisted, comScore, Inc. (SCOR) came up with the highest surprise of 233.3% while Acacia Research Corp. (ACTG) delivered the lowest surprise of -300%. Average earnings surprise for the industry was -0.1%. We expect Zacks Ranked #2 Core-Mark Holding Company, Inc. (CORE) to deliver positive earnings surprise in the upcoming quarter with year-over-year growth of 43.1%.  

Business Information Services: Of the 9 companies in our coverage, surprise from the industry ranged from -220% to 23.3% with an average of about -17.2%. The highest surprise came from ADT Corp. (ADI) with Global Geophysical Services, Inc. (GGS) throwing the worst negative surprise. We expect Zacks Ranked #1 Nielsen Holdings N.V. (NLSN) to deliver year-over-year growth of 17.8% in the upcoming quarter.  

Waste Removal: Of the 7 enlisted companies, US Ecology, Inc. (ECOL) came up with the highest surprise of 24% while Nuverra Environmental Solutions, Inc. (NES) delivered the lowest surprise of -50%. Average earnings surprise for the industry was -2.3%. We expect Zacks Ranked #3 Republic Services, Inc. (RSG) to generate highest year over year growth of 25% in the next quarter.

OPPORTUNITIES

Labor Intensive: Given the nature of intangible products offered by the service sector, it is labor intensive. The sector offers immense employment opportunities as it requires both skilled and unskilled labor for its smooth functioning. 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.

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/or maintaining a better retention ratio. It also opens the door to international trade.

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 which would otherwise be far more expensive.

With specialized services, these providers reduce the operational cost and in turn the overall costs of companies. Notably, an increased 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.

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 for 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 also looks promising as it is indispensable for companies that are fighting to survive in a 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 generate revenues 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 dampen the business of the service providers and affect their fundamentals.

Requires Continuous Spending for Research and Development: Importantly, consulting service providers need to remain abreast with the latest technologies through continuous spending on research and development. The performance of these providers can be hampered if they do not acclimatize or adopt new services to account for the ongoing developments.

Training, Maintaining Skilled Workforce: Since skilled workers are always in demand, there remains a possibility of a high turnover rate within the sector. The training of unskilled workers or taking in new skilled workers increases operational costs, thereby affecting margins. This sector needs to have a more skilled workforce to take advantage of technology that develops at a relatively rapid pace.

Competition: Maintaining or increasing market share remain challenging for business service providers. As discussed earlier, the main business of one company can be a business service for another; 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.

To Conclude

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

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. In the last reported quarter, Healthcare Services Group, Inc. (HCSG) inked an asset purchase agreement with Platinum Health Services, LLC to acquire substantially all of its operating assets. Cardtronics USA, Inc., wholly owned subsidiary of Cardtronics, Inc. (CATM) acquired ATM business assets from Chandler, AZ-based CGI, Inc. or CGI Direct ATM, adding approximately 1,000 merchant-owned ATMs to its nationwide U.S. fleet.

Avis Budget Group, Inc. (CAR) acquired Payless Car Rental, the sixth largest car rental company in North America, for approximately $50 million in cash. The addition of the Payless brand will give Avis Budget Group a strong position in the fast-growing deep-value segment of the car rental industry. Furmanite Corp. (FRM), agreed to acquire certain professional service assets of ENGlobal Corporation (TENG). Further, Mac-Gray Corp. (TUC) agreed to be acquired by CSC ServiceWorks, Inc. for $524 million.

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.

According to the report released by Staffing Industry Analysts, the staffing industry is expected to grow in mid-single digits in 2013 and 2014, declining from growth of 7% in 2012 and 13% in 2011.

The sector might also attract new investors as nearly one-third of the companies under our coverage in the business service industry share profits with their shareholders via dividend payments. Dividend payments help in retaining stockholders confidence in the company. Dividend yield ranges from 1.16% at Core-Mark Holding Company to 7.42% at National Research Corp. (NRCIB). Notably, almost every company’s dividend yield betters the industry average.

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. The emerging economies such as India and China are also becoming important destinations for the business service sectors. On the flip side, the same poses challenges to employment growth in developed economies.

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