Getting to grips with Brown's spending bonanza

It's good news nearly all round for the markets after the review, says Jenne Mannion

There are far more stock market winners than losers following Gordon Brown's pre-election comprehensive spending review. Underpinning the Chancellor's review was the pledge to increase spending across a range of areas such as transport, health, housing, defence and science. Private sector companies that operate within these areas will be the obvious beneficiaries of the bigger budgets, although investment professionals said there was little news to surprise the market and dramatically brighten up the fortunes of individual stocks.

There are far more stock market winners than losers following Gordon Brown's pre-election comprehensive spending review. Underpinning the Chancellor's review was the pledge to increase spending across a range of areas such as transport, health, housing, defence and science. Private sector companies that operate within these areas will be the obvious beneficiaries of the bigger budgets, although investment professionals said there was little news to surprise the market and dramatically brighten up the fortunes of individual stocks.

Ashton Bradbury, a UK small and mid-cap fund manager at Old Mutual Asset Managers, said: "It is an obvious trend that expenditure is increasing in education, health and transport. Therefore, while much of the news is positive, it more or less reinforces what we already knew."

That increased expenditure will be funded by ambitious plans to increase savings in Whitehall running costs, ultimately cutting 105,000 public service positions in a bid to save £21.5bn per year. Although it is largely a case of wait and see, there is a small chance this could have wider negative ramifications for the economy, said Neil Cumming, a senior fund manager at Hichens Investment Management.

There are unlikely to be many stock market losers, given the government has pledged to increase rather than cut spending across many areas, although there is the risk that the loss of 105,000 civil service positions could dampen consumer spending.

Mr Cumming said: "There is a certain amount of scepticism over whether Gordon Brown can deliver the cost savings which are underpinning this ambitious spending programme. However, if he does abolish 105,000 positions, this could result in a significant number of people claiming unemployment benefits, and could have a detrimental affect on consumer spending growth."

Although the Government is aiming to cool consumer spending and the housing market at the moment, Mr Cumming said it is important to get the balance right. "There is a very fine line between touching gently on the brakes or doing it too much and making the engine stall, which can cause wider problems in the economy. The whole question of whether Gordon Brown can deliver these job cuts, and do so without affecting the wider economy, is something that only time can tell. If it does have an impact on the wider economy, then certain consumer or retail stocks will be the obvious losers," he said.

The increased spending on health, education and transport means further infrastructure and maintenance will be required as more hospitals, schools and rail networks are built. The companies that will ultimately benefit are those classed as PFI (public finance initiative) stocks, which are generally found in the engineering and construction sectors. Balfour Beatty, Serco Group and Carillion are well-positioned to win contracts in this area, Mr Cumming said.

Small private healthcare companies will benefit from a bigger NHS budget, according to Mr Bradbury. Two such companies that he holds in his Old Mutual fund are Synergy Healthcare and Care UK. Synergy Healthcare is involved in sterilising instruments, providing procedure backs, and linen hire and management. Care UK develops and operates nursing homes and hospitals. Earlier this year, it announced that profits had almost doubled in the six months ending 31 March, compared to a year before, due to signing new contracts with the Government and increasing fees.

The increase in the defence budget is good news for companies such as BAE Systems and Meggitt. But Ted Scott, a UK fund manager at Isis Asset Management, said the increase in the defence budget is small relative to other areas. However, Mr Cumming said: "While there is little surprise that the Pfi companies would benefit, defence stocks look like being new winners because there has been an increase. In the past this department has got a kicking."

The obvious company to benefit, he said, is BAE. However, he added that BAE has to repair its relationship with the British Government and should not take it for granted that it would automatically benefit from new contracts. "The Government's main gripe with BAE is that a number of projects have run over time and have not been delivered within budget, which has led to a lot of mudslinging between the two. As a result the Government has indicated that it is prepared to take its business to international firms, and consequently BAE will have to work hard to gain these contracts," Mr Cumming said.

Social housing will be the main beneficiary of increased spending on housing, with an extra 10,000 units to be provided by the end of the review period. Most of these will be built in London and the south-east, and private sector companies will vie to deliver these contracts. These include Berkeley Group and George Wimpey.

However, as Mr Bradbury points out, the increased expenditure from the Government is merely a drop in the ocean of new housing. "There is such strong demand from the private housing sector that the government's increased spending, although beneficial, would not make a substantial difference to the profits of these companies," he said.

The efficiency drive by the Government should be a windfall for the private sector. The £21.5bn in efficiency savings would almost certainly lead to significant demand for outsourced services. Poised to benefit is Capita, which already holds government outsourcing contracts such as managing the London congestion charge.

Another, said Mr Scott, is Isoft Group, a smaller company that develops and sells a range of information system products used by hospitals and healthcare organisations. It already holds a substantial contract with the NHS.

The increased spending on science should feed through to research and development, and the outcome could make a significant difference for certain innovative companies which have products in their early stages of development.

Mr Scott holds shares in Porvair, a small company that makes specialist materials for products ranging from drug-testing equipment to protective clothing. "A particularly exciting part of its business is fuel cell technology, which enable cars to run without using fossil fuels," Mr Scott said.

"Fuel cells may or may not take off. At the moment, cars can operate using fuel cell technology, but it is not commercially viable to do so. However, from an environmental perspective it is very exciting and there is an infinite supply of hydrogen. A lot more research needs to go into this to make it commercially viable, so any additional spending by the Government in this area is largely welcome." However, he added, there are risks that these products won't be as successful as hoped, so this company should be viewed as a high-risk investment.

Mr Brown announced that the Government would sell £30bn of assets by 2010, ultimately prompting a huge auction of land and property, such as office buildings. Nick Mansley, head of property strategy at Morley Fund Managers, said if the full £30bn sell-off was dominated by commercial property, then the scale of the sale would be substantial enough to cause a glut of property on the market, ultimately leading to lower prices.

However, he said, it's very early days and it is likely that the sale will include a broad range of assets and will probably take between five and 10 years. "It is also not clear how much of this is vacant or leased property, nor the potential for redevelopment," Mr Mansley said. Provided the sales are not concentrated in the commercial office sector, there are unlikely to be massive property losers, he added.

Ralph Brook-Fox, a UK analyst at Britannic Asset Management, said it is difficult to see any great windfalls for transport-oriented companies as a result of increased spending. He said: "The key issue is the quality of the rail infrastructure and I don't see the Government meddling with the day-to-day train operations. Hence, the review does not seem to imply any significant change for the service providers."

However, Mr Brook-Fox said that the Government, as part of its transport reforms, is also talking about giving greater powers to local authorities to introduce quality bus contracts with controlled fares. At present, only the London bus network is regulated, and this could extend selective regulation to other parts of the UK, which might eat into profits. A company that could be vulnerable to this is National Express, which enjoys a monopoly position and high profitability in the West Midlands.

WHO GAINS, WHO LOSES

THE WINNERS...

SERCO GROUP

Share price: 214p

One-year change: +36.0%

Three-year change: -45.7%

Neil Cumming, a senior fund manager at Hichens Investment Management, says: "Serco is already a major player in the UK's Pfi market, and the fact that there is going to be continued increased spending in health, education and transport will enable this company to pitch for Pfi contracts. This will drive the profitability of the group further forward.

BAE SYSTEMS

Share price: 210p

One-year change: +43.3%

Three-year change: -42.9%

As the UK's prime defence and civil aerospace company, BAE is in a prime position to benefit from increased expenditure. Mr Cumming says that, despite recent problems with its relationship with the British Government, the increased commitment to defence and security spending will hopefully enable BAE to participate in winning new contracts from the Government.

BALFOUR BEATTY

Share price: 271p

One-year change: +41.7%

Three-year change: +44.1%

Adrian Frost, a UK fund manager at Artemis, is confident that Pfi expenditure is on the increase, a trend which is reinforced by Mr Brown's spending review. Stocks like Balfour Beatty, the international engineering and construction group, will benefit. Mr Frost says that, like most Pfi stocks, the operations and expenditure of Balfour Beatty are highly visible. "The company has decent international exposure and good expertise in areas such as rail and power. It's a business that generates decent cash. While this is not the cheapest share in the world it offers good long-term value," Mr Frost says.

CAPITA GROUP

Share price: 311p

One-year change: +47.2%

Three-year change: -31.7%

Ted Scott, UK fund manager at Isis Asset Management, says Capita's business model is highly attractive and it is in a strong position to benefit from the growing demand for outsourcing. Capita provides an integrated range of services across the UK's public and private sectors in customer services, human resource services and software services. One of its best-known contracts is the administration for the London congestion charge. Capita recently entered the FTSE 100 index, following strong share price performance. The company is growing fast and benefiting from public sector contracts. "This is not a mature business, there is a lot of growth ahead of it," Mr Scott says.

AND THE LOSERS

NATIONAL EXPRESS GROUP

Share price: 660p

One-year change: +13.6%

Three-year change: -30.3%

Ralph Brook-Fox, an investment manager at Britannic Asset Management, says National Express could feel the pinch if the government progresses with moves to allow local authorities to regulate, or introduce quality bus contracts. National Express currently enjoys a monopoly in the West Midlands, which could be affected by such a move. "However, acting in National Express's favour is the fact it is a very efficient operator with a modern fleet and some of the lowest fares in the country, so it would be difficult to see what the rationale for the council intervening would be," he says.

GUS

Share price: 820p

One-year change: +20.1%

Three-year change: +31.2%

Mr Cumming says that, if consumer spending does slow as a result of the job cuts, then a company like GUS, which owns the Argos and Homebase chains, could suffer. He says GUS would see sales growth become more difficult to achieve, particularly through its Argos stores. "Many Argos customers are the lower socio-economic group who have been benefiting from more jobs in health, education, transport etc. Therefore, lower jobs could have a significant impact on sales, but this is more a potential scenario rather than one of any certainty," Mr Cumming says.

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