Serco shares rally as fightback continues

Up 68% since December, the company is in full recovery mode and some say the shares can keep rising.

A two-year high for Serco (LSE:SRP) shares today highlighted the progress being made by Rupert Soames as the outsourcing firm continues the "long road to recovery" it started five years ago.

The FTSE 250 index stock rose 5% to 142p after an update on first-half trading revealed 4% organic sales growth and an "extremely strong" order intake of more than £3 billion. It now expects full-year revenues to be around the top end of its £2.9 billion-£3 billion guidance.

Noting the company's first organic growth rate for five years, analysts at Jefferies think the shares have the potential to reach 170p. They continue to look for a token dividend payment of 0.5p a share with annual results next February, which would be the first such award since the dividend was pulled at the height of the Serco crisis in 2015.

Source: TradingView Past performance is not a guide to future performance

When former Aggreko boss Soames took charge in 2014 the company was mired in problems, the most serious being the allegations that it defrauded the Ministry of Justice over prisoner escort and electronic tagging contracts.

As well as improving the battered relationship with Whitehall, Soames shored up the balance sheet with a £550 million rights issue priced at 101p. He also got rid of unprofitable contracts and made write-downs totalling £1.4 billion.

Soames, a grandson of Winston Churchill, always insisted that the recovery would be long and painful - and so it has proved. A strong performance in 2018 marked an inflexion point for the ex-FTSE 100 company after several years of declines, with today's update signalling further progress as profits and margins are both well up on the first half of last year.

But confidence in the outsourcing sector in the wake of the Carillion collapse remains fragile, with analysts at Liberum and Peel Hunt targeting 150p and 146p for Serco after today's update.

Serco's efforts to win over investors received a major lift recently with the signing of contracts for asylum accommodation and support services in the UK valued at £1.9 billion and for defence healthcare provision in Australia worth £600 million.

It is expected that 2019 will be the third year in a row in which order intake exceeds revenue, reinforcing Jefferies' forecasts for mid-single digit organic revenues growth in 2019 and 2020.

Serco's prospects have been further lifted by the recent acquisition of the Naval Systems Business Unit (NSBU), which adds to the scale and capability of its US defence business.

Serco employs 6,000 people in North America, of whom 2,300 work in defence, and has been providing services to the US Navy for nearly 30 years. NSBU, which employs around 1,000 people, will bring world-class ship and submarine design, systems, and engineering services.

In 2020 - the first full year of ownership - NSBU is expected to contribute revenues of approximately US$370 million (£285 million) and underlying earnings of $28 million (£21 million).

Last month's proposed acquisition worth £173 million is being financed through a new debt facility of up to £75 million, plus equity placing. Serco today reiterated its guidance for £250 million of net debt at the end of 2019, with underlying leverage of around 1.5x.

Jefferies added:

"In our view, Serco will report positive free cash flow in 2019, which is a necessary condition for management to reinstate the dividend and we believe a token 0.5p final payment will be proposed at year-end."