Conservative win would hit infrastructure shares

 

An expected election victory for the Conservatives next year should hit infrastructure firms as government spending tumbles, while outsourcing groups and some defence contractors may gain.

Britain's budget deficit is forecast to reach a record 175 billion pounds or 12 percent of gross domestic product - bigger than most leading world economies - and how to cut it is a key political theme in the run-up to an election due by June next year.

All major parties promise deep cuts in public spending, with the Conservatives seen as the party most likely to go through with the biggest cuts.

A YouGov poll over the weekend showed support for the Conservatives at 41 percent, 11 percentage points ahead of the Labour party, while other polls have also consistently put the Tories in a commanding lead.

"Any public spending-related area is likely to be vulnerable for sure. Everything's on the agenda and infrastructure companies attract a lot of government spending" said Grahame Exton, fund manager at Tilney Investment Management in Liverpool.

He cited engineers WS Atkins , Invensys and Balfour Beatty and building group Carillion as examples of companies which were likely to see revenues take a hit as government departments like transport and health severely cut spending.

"A Conservative government would be more negative for firms that rely on public spending such as transport or health contractors and consultants," said Azad Zangana, European economist at Schroders.

The Conservatives pledged this month to cut spending by 23 billion pounds by 2015 by freezing public sector pay, trimming benefits and finding efficiencies if elected next year. 

"Key projects, which are rational and high priority may be cut on the basis of political expediency" said Mark Costar, fund manager of the 350 million pound JO Hambro Capital Management Growth Fund.

"The area to avoid is public sector capital spend rather than revenue spend as this is the most vulnerable and the area where more political footballs fly around" said Costar.

DEFENCE MIXED, OUTSOURCERS TO GAIN

The Conservatives have committed to maintaining a UK military presence in Afghanistan where 9,000 troops are fighting, putting pressure on other big-ticket military projects like the Airbus A400M and Eurofighter Typhoon warplanes.

Costar said companies involved in major manufacturing projects like BAE Systems were likely to be hard hit, while Babcock and BT Group would continue to benefit from contracts to refurbish existing military hardware.

UK sales for BAE Systems accounted for 3.4 billion pounds in 2008, around 18 percent of total sales.

Other companies that provide parts for large scale military projects include Rolls Royce and Cobham.

Outsourcing companies provide the clearest opportunities for investors to back the winners in the event of a Conservative government, analysts said.

"Capita and Serco, and in the defence sector (engineer) Babcock International and BT Group - all these companies are in a position to drive down costs" said Andrew Nussey, analyst at KBC Peel Hunt. 

He said this would make them attractive alternatives to spending directly through government agencies and departments.

The fear of a shrinkage in budgets is already denting some companies. JO Hambro's Mark Costar pointed to infrastructure business Mouchel as an example of a company which has suffered on expectations of a Conservative victory and could continue to do so should they take power.

Shares in the company fell earlier this month after analysts expressed concern about a likely spending lull caused by the upcoming election.