ii view: outsourcer Serco shares confident outlook

A strong and differentiated market position, plus hopes for growing shareholder returns. Buy, sell or hold?

New medium-term revenue and profit expectations 

ii round-up:

Government services provider Serco (LSE:SRP) today outlined new medium-term targets, with revenues now expected to grow faster than the market, profits faster than its revenues, and returns to shareholders faster than profits.

The new targets are based on its 2022 performance so as to exclude the distorting impact on revenues and profits of the Covid crisis, which is expected to be much smaller in 2022 than in 2021.

Serco shares rose marginally in UK trading, leaving them up by almost 13% year-to-date. That’s ahead of a 10.5% gain for the wider FTSE All-Share index, although below a 14% gain for support services rival Capita (LSE:CPI). 

Buoyed by Covid services to the government such as testing sites, Serco previously raised its 2021 profit and revenue forecasts to at least £225 million and £4.4 billion respectively. Revenue and underlying trading profit for 2020 came in at £3.88 billion and £163 million respectively. 

However, revenue and profit on the same basis for 2022 are expected to come lower at up to £4.2 billion and £195 million given an expected easing in pandemic related government services. 

Serco operates across the five sectors of Defence, Justice & Immigration, Transport, Health and Citizen Services.

Given a strong and differentiated market position, Serco now expects to grow its medium-term revenues at twice the rate of the broader market. That should be between 4% to 6% from the base year of 2022. 

Its Business-to-Government (B2G) platform should help improve its profit margins by between 0.5% to 1% to 5% to 6%, with its robust financial position aiding a reduction in dividend cover from above 4 times earnings to around 3 times earnings over coming years and helping shareholder returns to increase. 

Full-year results are scheduled for 24 February. 

ii view:

Serco operates across the four regions of the UK & Europe, North America, Asia Pacific and the Middle East. Examples of services it helps deliver include immigration-related assistance in the UK and Australia and healthcare insurance eligibility services in the US. Most of its profits now come from outside the UK. 

For investors, management expectations for Covid-related work to decline in 2022 needs to be remembered. The dividend was previously halted, and revenues generated overseas can be affected by currency moves. But positive medium-term targets follow a previous upgrading of 2021 forecasts. The discovery of the Omicron Covid variant means there could be more Covid work for Serco in 2022, while the shares also sit on a dividend yield of around 2%, not totally derisory in a an era of ultra-low interest rates. For now, and with analysts continuing to estimate a fair value target price of 175p, prospects for long-term upside look favourable. 

Positives: 

• Diversity of both services offered and geographical location
• Ongoing government desire to reduce costs

Negatives:

• Covid-19 work expected to diminish
• Currency movements can drag on performance

The average rating of stock market analysts:

Strong buy