ii view: outsourcer Serco upgrades profit forecast

First-half trading update to 30 June

• Expects revenue down 4% year-over-year to around £2.4 billion
• Expects adjusted operating profit down 5% to around £140 million

Full-year 2024 Guidance:

• Now expects annual adjusted operating profit of £270 million, up from a prior £260 million

Chief executive Mark Irwin said:

“We continue to explore new ways to bring together the right people, the right technology and the right partners to help governments around the world respond to the complex and difficult challenges they face.  

“As we enter the second six months of the year, while mindful of a potential impact internationally from elections in 2024, we remain optimistic about the quality of our pipeline of potential new work to support our medium-term growth targets."

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ii round-up:

Government services provider Serco Group (LSE:SRP) today pointed to an expected drop in first half profitability but did raise its forecast for full-year profit.

Reduced immigration processing volumes in Australia and costs to establish new work are expected to contribute towards an interim operating profit of around £140 million, down from last year’s £148 million. However, a ramping up of new contracts, improved operational efficiency and contributions from acquisitions are now forecast to help generate an adjusted annual operating profit of £270 million this year, up from management’s previous estimate of £260 million.

Shares in the FTSE 250 company rose 5% in UK trading having come into this latest news up by a similar amount year-to-date. That’s ahead of a 4% gain for the FTSE 250 index itself and in contrast to a near two-fifths decline at corporate services focused Capita (LSE:CPI).    

Serco provides services to government departments including defence, immigration, justice, healthcare, and customer services both in the UK and overseas. 

Growth in defence and justice helped counter reduced sales for customer services in relation to US healthcare insurance provision, with expected first-half revenue of around £2.4 billion, down from £2.5 billion in the first half of 2023. 

Expected free cashflow over the year of £150 million is up from the board’s previous estimate of £140 million. Similarly, expected annual adjusted net debt of £165 million is down from a previously estimated £175 million, leaving its ratio of net debt to adjusted profits (EBITDA) at 0.6 times.  

Broker UBS reiterated its ‘buy’ rating on the shares post the update. First-half results are scheduled for 1 August. 

ii view:

Employing more than 50,000 people, Serco helps governments design services, integrate systems, outsource case management and engineering services, and oversee assets & facilities. The UK and Europe accounted for its biggest slice of sales at 50% in 2023, followed by North America at 28%, Asia Pacific 17% and the Middle East the balance of 5%.  

For investors, pending elections both in the UK and overseas could see governments changing their arrangements, potentially reducing demand for Serco's services. Reputational and executional risk in running services such as immigration detention centres and prisons should not be ignored. Costs and, in particular, wages for businesses are now elevated, while an estimated price/earnings (PE) ratio above the three-year average may suggest the shares are not obviously cheap.  

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To the upside, stretched national finances following both the pandemic and the energy price crisis could leave potential new governments happy to run with outsourcers like Serco. Diversity of both customer sector and geographical region exists, £60 million of a £140 million share buyback programme is still running, while the dividend is being paid again, with the shares offering a forecast dividend yield of just over 2%.  

For now, and while upcoming government elections are reason for caution, a consensus analyst fair value estimate above 220p per share plus a recent improvement in the profit outlook underpins continued optimism in the City. 

Positives: 

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

Negatives:

• Elevated costs
• Currency movements can drag on performance

The average rating of stock market analysts:

Buy