Outsourcing Industry Stock Outlook: Near-Term Prospects Take a Hit

The global outsourcing services industry has been unstable over the past few years. A report from statista shows that market size of $ 88.9 billion in 2017 was same as in 2015 and improved from $ 76.9 billion in 2016. However, it marks a steep decline from $ 104.6 billion in 2014.

While increasing demands for technology expertise, efficiency and cost reduction has kept revenues in good shape, heightened trade war tensions are a concern. Increasing U.S. protectionism is hurting growth prospects of this industry.

Moreover, the U.S. government’s plan to reduce the issuance of H1-B visas to foreign nationals, particularly from countries like India, is a key concern for this industry.

Industry Outpaces Sector and S&P 500 Index

Looking at the industry's stock market performance, it is obvious market participants appear optimistic about the group's outlook. The Zacks Outsourcing Industry, which is a group within the broader Zacks Business Services Sector, has outperformed its sector as well as the benchmark index in the past year.

While the stocks in this industry have collectively gained 26.9% in the past year, the Zacks S&P 500 Composite and Zacks Business Services Sector have rallied 13.3% and 21.3%, respectively.

One-Year Price Performance

 

Outsourcing Stocks Look Expensive

The outperformance of the industry over the past year has led to its relatively rich valuation.

Price to Forward 12 Months

Comparing the industry to the S&P 500 on the basis of price-to-forward 12 months (P/E-F12M) earnings, we see that the industry’s 22.41X is ahead of the S&P 500’s 17.11X.

 

However, a comparison of the industry with that of its broader sector indicates that the group is trading at a decent discount. The Zacks Business Sector’s forward 12-month P/E- is 22.77, which is above the industry’s 22.41.

Price to Forward Earnings Growth

Comparing the industry to the S&P 500 on the basis of price to forward earnings growth, we see that the industry’s 2.33X is again ahead of the S&P 500’s 1.84X.

Comparison with the Zacks Business Services sectors confirms that the stock is trading at an expensive rate. It is also ahead of the sector’s 2.02X.

Outperformance May Continue on Solid Earnings Outlook

The outsourcing services industry has been in a decent shape driven by demand for expertise, efficiency and cost reduction. Most of the companies maintain a geographically diverse revenue base and rely on business moves such as transformation initiatives and technological improvement to expand market share and boost revenues.

But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. The valuation discussion shows that market participants are willing to pay up for these stocks already, potentially limiting further upside from current levels.

One reliable measure that can help investors understand the industry’s prospects for a solid price performance going forward is its earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.

The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.

Price and Consensus: Zacks Outsourcing Industry

 

This becomes clearer by focusing on the aggregate bottom-up EPS revision trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Please note that the $ 2.74 EPS estimate for the industry for 2018 is not the actual bottom-up estimate for every company within the Zacks Outsourcing Industry but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the industry’s earnings per share for 2018 but how this estimate has evolved recently.

Current Fiscal Year EPS Estimate Revisions

As you can see here, the $ 2.74 EPS estimate for 2018 is up from $ 2.53 at the end of September 2017. In other words, the sell-side analysts covering the companies in the Zacks Outsourcing have been steadily raising their estimates.

Zacks Industry Rank Indicates Gloomy Near-Term Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued underperformance in the near term.

The Zacks Outsourcing industry currently carries a Zacks Industry Rank #155, which places it at the bottom 39% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Outsourcing Stocks Promise Long-Term Growth

While the near-term prospects do not look welcoming for investors, the long-term (3-5 years) EPS growth estimate for the Zacks Outsourcing industry appears promising. The group’s mean estimate of long-term EPS growth rate is at the current level of 10.5%. This compares to 9.8% for the Zacks S&P 500 composite.

Mean Estimate of Long-Term EPS Growth Rate

 

In fact, the basis of this long-terms EPS growth could be the recovery in the top line that the Zacks Outsourcing industry has been showing since the beginning of 2013.

Revenues: Zacks Outsourcing Industry

 

Bottom Line

Trade war tensions are intensifying with time and increasing U.S. protectionism should act as major hindrance to outsourcing firms in the United States. Additionally, companies in the industry continue to suffer from client concentration and stiff competition.

Since the near-term prospect of the industry does not appear encouraging, it would be prudent to stay away from some weak stocks that are likely to underperform.

Below are three stocks which carry a Zacks Rank #4 (Sell) or 5 (Strong Sell) and have witnessed downward or no earnings estimate revisions in the last 60 days.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

StarTek, Inc. (SRT): The stock of this Colorado-based provider of business process outsourcing services has declined 26.4% in the past three months against the industry’s rally of 11.9%. The Zacks Consensus Estimate for current-year EPS has been stable in the past 60 days. Currently, it has a Zacks Rank #5.

Three-Months Price Performance: SRT

 

Adecco Group AG (AHEXY):  The stock of this Zurich-based provider of workforce solution has shed 16.8% in the past three months. The Zacks Consensus Estimate for current-year EPS moved down 4.7% in the past 60 days. Currently, it has a Zacks Rank #5.

Three-Months Price Performance: AHEXY

 

Broadridge Financial Solutions, Inc. (BR): The stock of this New York-based global fintech leader though up 8.9% in the past three months has underperformed its industry’s rise of 10.6%. The Zacks Consensus Estimate for current-year EPS has been stable in the past 60 days. Currently, it has a Zacks Rank #4.

Three-Months Price Performance: BR

 

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