One of the most common reasons behind profit warnings over the past few years has been delays to contracts being awarded. This is either a client pushing back the start date or just sitting on their hands and not making a decision.

The outcome of the UK general election inevitably means this negative market factor is here to stay for longer.

A hung parliament is possibly the worst outcome for companies that serve the public sector. We don’t know who is running
the country, let alone how they plan to fund spending plans.

‘The hiatus in government decision making caused firstly by last year’s Brexit vote and then the calling of the snap general election is now set to continue for an indefinite period,’ says Shore Capital analyst Robin Speakman.

‘Contract decision making and awards (along with efficiency /policy programmes) now appear to be pretty low down in the list of priorities.’

Which stocks look vulnerable?

Support services is one of the sectors most at risk. Many of the companies on the UK stock market work for the government directly or indirectly. The uncertain political situation may also weigh on private sector contract decisions, too.

Outsourcing groups Capita (CPI), Mitie (MTO), Serco (SRP) and G4S (GFS) look most at risk among the larger quoted support services firms.

Capita last September issued a profit warning on the back of a sluggish performance in the second half of 2016. It said some of its clients had delayed their decision making.

That closely followed a similar shock from Mitie which blamed a weak outlook for UK economic growth and uncertainty generated by the Brexit vote for its September 2016 profit warning.

In particular, Mitie cited government budget constraints and pressures to clients’ pricing for its gloomy outlook.

Don't be fooled by share spike

Mitie’s share price shot up earlier this week (12 June) after full year results showed the first signs of a turnaround under new boss Phil Bentley who is aggressively cutting costs.

I still see little reason to invest in the company as it has tiny profit margins and messy accounts. Furthermore, it is almost entirely dependent on the UK (>97% of revenue), meaning it is extremely vulnerable if public and private sector decision making keeps being delayed.

‘The contract portfolio is exposed to re-bid risks and large contracts may be re-tendered at lower margins or lost to competitors,’ says investment bank UBS following Mitie’s full year results.

‘The public sector is also a source of uncertainty given potential exogenous shocks to budgets and so pricing/volumes/contract changes.’

Other risks ahead

Shore Capital’s Robin Speakman says another election-related risk to the support services sector is strikes over pay, particularly among government outsourcing companies.

‘We expect “pay” to come to the fore following the Labour Party’s populist manifesto agenda themes. We can foresee instances of industrial action increasing,’ he says.

‘Margin concerns come to the fore with a lesser ability in recent years to pass on higher costs under many contract arrangements (particularly where margins have been in double digits).

‘Indeed, the levers of industrial action may come to the surface prominently across the public sector in coming months with the aim of forcing the policy agenda towards the populist agenda, making governance challenging.’

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