Commercial & Professional Services Sector – Poised for Growth amidst Rapid Technological Development

I. Sector Landscape and Outlook

The commercial and professional service sector plays an important role in Australia’s economic growth in terms of productivity improvement and employment generation. Professional services may entail businesses such as management consultants, human resource management consultants, PR consultants, accountants, etc. Commercial services consist of several offerings ranging from waste management solutions, vehicle leasing, vehicle fleet management, supply-chain logistics, etc. Australia possesses a strong capability in these services and has grown majorly due to increased outsourcing of business management services.

Figure 1. Types of Commercial & Professional Services

Data Source: Business.gov.au; Chart Created by Kalkine Group

As charted below, S&P/ASX 200 Commercial & Professional Services Index has outperformed S&P/ASX 200 Index by 7.76% over the last 5 years.

Figure 2. S&P/ASX 200 Commercial & Professional Services (Industry Group) vs S&P/ASX 200 (*5 Year)

Data Source: Refinitiv, Thomson Reuters *29^th October 2015 – 29^th Oct 2020; Chart Created by Kalkine Group 

Growing Significance of Professional and Commercial Services in the Economy

• Business Investment: Although the business environment during 2020 remained subdued due to the pandemic, the business services sector has been a positive contributor to factors that drive economic growth. As depicted in the chart below, the share of other business services (including professional, scientific, and technical services; administrative and support services) in Business Investment has witnessed a positive trend between 2013-14 to 2018-19. Moreover, these services have the second largest share in Business Investment after Mining.

Figure 3. Industry Share of Business Investment

Data Source: ABS (** Includes: information media and telecommunications; rental, hiring and real estate services; professional, scientific, and technical services; administrative and support services.)

• Nominal Gross Value Added: Business services including professional, scientific, and technical services have been the highest contributor to Nominal Gross Value Added since 1998-99 till 2018-19. This can be attributed to the growing relevance of professional services as Australia undergoes continuous technological transformation.

Figure 4. Industry Share of Output

Data Source: ABS (** Includes: information media and telecommunications; rental, hiring and real estate services; professional, scientific, and technical services; administrative and support services.)

• Contribution to Employment Growth: The Business Services sector’s has been the second highest contributor to employment growth after household services from 2016 till date. The contribution of other services has also risen slightly over the period. With the increasing demand for high-skilled workers in the commercial and professional services sector, this trend may continue in the upcoming periods, subject to the pandemic impact.
  

Figure 5. Employment Growth by Industry

Data Source: ABS (** Includes agriculture, forestry & fishing; transport, postal & warehousing. and electricity, gas, water & waste services)

Growth Drivers for Professional and Commercial Services for Stocks Under Consideration

The following growth drivers relate to specific segments in the Commercial & Professional Services Industry that are trending due to the relevance of services provided.

• COAG Waste Export Ban - The Council of Australian Governments issued a timetable for banning waste plastic, paper, glass, and tyres. Australians create around 67 million tonnes of waste each year. In 2018-19, 4.4 million tonnes of this waste were exported. Notably, the ban will begin from unprocessed glass, which will be banned from export (in a whole or broken state) from 1 January 2021. This development will provide a significant boost to the waste management industry which has the potential to evolve as a large economic sector.

Figure 6. Waste Export Ban Timetable

Data Source: Coag.gov.au, Chart Created by Kalkine Group

• Rise in Intellectual Property Applications: According to Australian IP Report 2020, standard patent applications in Australia have grown at an average annual rate of 2.5% over the period covering 2010 – 2019. Trademarks and design applications over the 10-year period (2010-2019) reported a CAGR of 2.74% and 2.73%, respectively. Therefore, growing IP applications by residents and non-residents will prove beneficial for IP service providers.
  

Figure 7. Standard Patent Applications in Australia - Direct & via Patent Cooperation Treaty (PCT)

Data Source: ipaustralia.gov.au; Chart Created by Kalkine Group

• Importance of Salary Packaging Services: Salary packaging businesses efficiently and effectively deliver the value of legislative concessions to eligible employees while maintaining a high standard of compliance for employers. McMillian Shakespeare Limited is one of the five outsourced salary packaging and novated leasing providers represented by The National Automotive Leasing and Salary Packaging Association (NALSPA). Notably, NALSPA is engaged in salary packaging arrangements of over 800,000 employees.

• Boost to the Supply-Chain Logistics Industry: Budget 2020-21 consists of an investment worth $107.2 million for the Government’s Supply Chain Resilience Initiative, which forms part of the JobMaker plan. The Government aims to identify the essential goods and services critical to Australians during these critical times and evaluate supply chain resilience. Consumer staples, which form the daily essentials for Australians, account for ~80% of Brambles Limited’s revenues.
  

Key Risks/Challenges

Figure 8. Key Risks in the Commercial & Professional Services Sector

Source: Kalkine Group

• Performance of Services Index (September 2020): The Australian Industry Group Australian Performance of Services Index (seasonally adjusted) declined by 6.3 points to 36.2 points in September 2020. However, the trend estimate for the month was up by 1.7 points to 40.0 points. Notably, the index depicted a positive trend in July before declining in August and September due to activity restrictions and border closures.

• Economic Uncertainty from COVID-19: The pandemic impacted demand across the waste management industry due to restrictions on movement, disrupted the supply chain, and significantly impacted business investment. Therefore, the sector will continue to be impacted if the current economic conditions continue to prevail.
  

• Competition Risk: With large number of businesses and individuals entering the Commercial & Professional Services space, each player has a significant amount of competition to go up against. Companies operate in competitive markets which can lead to loss of business in case they do not meet customer expectations or increasing intensity of competitor activity.

• Technological Disruption: Increasing use of electronic systems and processes by regulatory authorities, digital supply chain solutions, and technological advancements in the salary packaging and asset management space may pose difficulty for the industry players to sustain in the long run in the absence of related enhancements in the business.
  

• Changes in Regulatory Environment: Firms operating in the Commercial & Professional Services sector are exposed to a variety of federal, state, and local laws and regulations in Australia. For instance, state-based waste levies, carbon tax, environmental regulation and planning regulations have impacted Cleanaway Waste Management’s historical results. Similarly, regulatory uncertainty concerning warranty and insurance products is a key risk for McMillian Shakespeare’s Retail Financial Services segment.

Outlook: Employment in the Commercial & Professional Services sector has been rising on the back of a booming mining industry. In FY19, the Professional, scientific, and technical services industry was one of the largest contributors to employment growth, witnessing an increase of 5.1% on the previous year. As a result of transition to the digital side of business, the demand for professional services, particularly in the consulting industry has increased significantly. The rising importance of automated processes in tax and audit, human resources, supply chain management, etc., has compelled the businesses to change the traditional methods to ones that are more suited in a digital world.

As the economy recovers from the pandemic and Australia reaches a state of ‘COVID Normal’, the Commercial & Professional services is expected to gain more popularity as new technologies continue to automate processes, increasing the demand for higher-level problem solving skills from workers. Outsourcing of business services will become imperative to generate efficiency gains and sustain in a competitive environment.

II. Investment theme and stocks under discussion (BXB, IPH, CWY and MMS)

After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on ‘EV/EBITDA’ method.

1. ASX: BXB (Brambles Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$ 15.04 Billion)

Brambles Limited offers supply chain logistics solutions to FMCG, beverage, retail, and general manufacturing industries through sale of reusable pallets, crates, and containers under the CHEP brand name.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~30.4% on 29 October 2020 closing price. For the said purposes, we have taken peers such as Cleanaway Waste Management Ltd (ASX: CWY), Bingo Industries Ltd (ASX: BIN), SG Fleet Group Ltd (ASX: SGF), etc. At the same price, the stock of BXB was offering a dividend yield of ~2.58%.

2. ASX: IPH (IPH Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$ 1.46 Billion)

IPH Limited is a leading provider of intellectual property services with a wide portfolio of IP products and services. It staffs close to 900 employees, serves Fortune Global 500 corporates, and operates in the Asia-Pacific region.  

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~37% on 29 October 2020 closing price. For the said purposes, we have taken peers such as Smartgroup Corporation Ltd (ASX: SIQ), Mcmillan Shakespeare Ltd (ASX: MMS), QANTM Intellectual Property Ltd (ASX: QIP), etc. At the same price, the stock of IPH was offering a dividend yield of ~4.19%.

3. ASX: CWY (Cleanaway Waste Management Limited)

(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$ 4.32 Billion)

It is one of the leading waste management, and recycling companies with specialised infrastructure assets and fleet of waste collection transport.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~11.6% on 29 October 2020 closing price. For the said purposes, we have taken peers such as Bingo Industries Ltd (ASX: BIN), Smartgroup Corporation Ltd (ASX: SIQ), SG Fleet Group Ltd (ASX: SGF), etc. At the same price, the stock of CWY was offering a dividend yield of ~1.95%.

4. ASX: MMS (McMillan Shakespeare Limited)

(Recommendation: Hold, Potential Upside: High Single-Digit, Mcap: A$ 724.28 Million)

McMillan Shakespeare Limited is a provider of financial products and services such as salary packaging, asset management, vehicle finance, insurance, and warranty.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~7.2% on 29 October 2020 closing price. For the said purposes, we have taken peers such as Smartgroup Corporation Ltd (ASX: SIQ), SG Fleet Group Ltd (ASX: SGF), QANTM Intellectual Property Ltd (ASX: QIP), etc. At the same price, the stock of MMS was offering a dividend yield of ~7.90%.

Note: All the recommendations and the calculations are based on the closing price of 29 October 2020. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).

Disclaimer

Kalkine New Zealand Limited is authorised to provide class advice only. The information on this site does not take into account any of your investment objectives, financial situation or needs. Before you make a decision about whether to acquire a financial product, you should obtain the Product Disclosure Statement from the product issuer. You should consider the appropriateness of advice taking into account your own objectives, financial situation and needs and seek independent financial advice before making any financial decisions.