Improving Economy to Fuel Business Services Growth in 2018

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Stocks in the Business Services industry have been strong performers of late, reflecting overall favorable trends. These are expected to further drive the companies in the near- to medium-term.

GDP Growth to Accelerate

Gross Domestic Product (GDP) grew at a seasonally adjusted annual rate of 2.3% in the first quarter of 2018, following 2.6% gain in the fourth quarter of 2018, per the “advance” estimate released by the Bureau of Economic Analysis.

The slowdown in growth was mainly due to seasonal quirk and economists expect growth to accelerate in the second quarter. Lower corporate and individual tax rates along with increased government spending are expected to push annual economic growth to the 3% target.

Significant Job Additions

The industry, which offers intangible products, has immense employment opportunities as it requires both skilled and unskilled labor for its smooth functioning.

In April, unemployment dropped to 3.9%, the lowest since December 2000, indicating that the labor market continues to be robust.

Meanwhile, U6, the most rigorous metric of unemployment in the U.S., declined to 7.8%, its lowest level in 11 years. This measure takes into account individuals who are not searching for employment or those who are working part time since they cannot secure full-time employment.

Payrolls were added for 91 straight months, the longest streak since the Labor Department started tracking this data in 1940s.

At the forefront of jobs gains last month was professional and business services, which added 54,000 jobs. Over the year, the sector has added 518,000 jobs.

Manufacturing and healthcare sectors added 24,000 jobs each in April. Job additions in mining amounted to 8,000.

Broadly, the Trump administration’s business-friendly approach, a strong U.S. economy, reduced tax rates, robust manufacturing and non-manufacturing activity, and improvements in the labor market and higher government spending should support additional hiring and wage gains this year.
 

Global Expansion

Major business services companies are exploring growth opportunities abroad, especially in the growing markets. Recently Avis Budget Group’s (CAR Free Report) subsidiary Avis Car Rental announced its relaunch in Japan at Chitose International Airport on Hokkaido Island. The move is Avis’ latest strategy to enhance its global footprint by focusing on growing markets, which are witnessing rising car rental demand.

First Data Corporation (FDC Free Report) has designed its business segments in a manner that supports global expansion. Appropriate segmentation of business allows the company to strengthen its client base and further globalize its offerings. The company’s comprehensive offerings include retail point-of-sale, e-commerce services, credit solutions, next generation offerings such as mobile payment services, webstore-in-a-box solutions, cloud-based point-of-sale operating system and value-added solutions. First Data has made steady progress with its SMB turnaround plan, which is expected to boost the company’s North American merchant business.

Cost Reduction

All business operators prefer to minimize cost of operation and maximize margins. The business services industry offers cost-effective services that would otherwise be far more expensive for companies.

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 Business Services margins have consistently grown in the past few quarters and will likely retain the momentum in the near term too. Importantly, Business Services margin expansion is better than that of S&P 500 Index.

Key Picks

Top-ranked stocks in the business services space include First Data Corp., Avis Budget Group and Xerox Corp. (XRX Free Report) . While Avis Budget currently sports a Zacks Rank #1 (Strong Buy), First Data and Xerox carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

First Data reported strong first-quarter 2018 results, surpassing the Zacks Consensus Estimate on earnings and revenues. Innovative product and services portfolio and expanding enterprise business continue to drive growth.

Avis Budget’s first-quarter 2018 results also surpassed the consensus mark on both counts. The company continues to benefit from higher demand, strong pricing and increased efficiency in business.

Xerox reported mixed first-quarter 2018 results, wherein the company’s bottom line lagged the Zacks Consensus Estimate but the top line surpassed the same.

Check out our latest Business Services Industry Outlook” here for more on the current state of affairs from an earnings and valuation perspective as well as the trend for this important industry.

Bottom Line

Given an improving economy, the business services industry is likely to be a worthy investment proposition in the near-to-medium term.

Rise in GDP, a better employment scenario, inflation approaching 2%, easing of the U.S. dollar and momentum in oil prices are all signs of improvement of the U.S. economy, which in turn should boost the business services industry. Trump’s business-friendly policies, including tax cuts and repeal of regulations, are additional tailwinds.

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