The elephant in the room

The chart below plots share price movement for each of our sub-sectors against the FTSE 250 index.

From Mar 07 to Mar 08 all bar construction outperformed the index. Since then all the sub-sectors have underperformed the index – most falling more from Mar 08 to Mar 09 and all rising less in the uplift of the following three months.

At first blush this seems odd for a sector that has resilient characteristics and carried strong momentum into 2009 (ref. Part 1 of this series on operating performance).

In the table towards the bottom we have plotted the relationship between Total Market Capitalisation, Price-Earnings Ratio (PER) and Earning Per Share (EPS). The column to focus on is the last one, which is the indexed change in each of these measures over the two year period from Mar 07 to Mar 09.

Here we can see that Market Capitalisation declines combined with Earnings Per Share increases means that PE Ratios have been decimated in all of our sub-sectors.

Of course the market is looking at forward earnings when pricing shares, and it looks like they are taking a very pessimistic view of future earnings growth. The question is, is that justified?

In our final chart below we take a look at a measure of resilience against movements in share price for the period Mar 08 to Mar 09.

Our Credo Resilience RatingTM looks at Order Book, Debt Ratios and Public Sector Exposure (see ‘Small Print’ for more details). This should be a reasonable guide to how the companies will perform in 2009 and this should be partly reflected in the relative Share Price movement – more resilient companies should have seen less share price decline relative to their peers.

There does appear to be a relationship between the Resilience Rating and Share Price movement for Consulting, FM and, at a push, Construction. In these sub-sectors notable outperformers are Tribal, ISG and MITIE.

There is no positive relationship between the Resilience Rating and share price movement in Infrastructure – if anything the relationship is slightly inversed.

And in Business Services, the only company with a stated order book is Serco, so even for consultants there are insufficient data points to spot a trend!
So what does all this data say in the round?

Firstly, performance should be relatively strong for the sector in 2009.

Secondly, the market has taken some account of the relative momentum and resilience of different companies for 2009.

Thirdly, the market has taken a very pessimistic view of forward earnings growth across all sub-sectors.

Why is this? Well, the elephant in the room is Public Sector spending from 2010 onwards. How much will spending decline, in which particular areas, and how will that impact prospects for the companies in our analysis?

In our next Credo Journal we will take a look at this important question before returning to the final two parts of this series. Judging by our recent discussions this should be both opportune and thought provoking.

Shareholder performance

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