Set to be Mitie again

Investors willing to take a far-sighted view on the issues facing outsourcer Mitie could garner attractive rewards. That's because, while organic growth has slowed nearly to a stop, there is reason to expect better things as 2011 progresses - indeed, Mitie has even reported encouraging signs. Meanwhile, dull trading and investors' anxiety following the collapse of other support-services providers mean that Mitie's shares have been de-rated - and that's what provides the buying opportunity.

True, there are sensible reasons why Mitie's shares sell on a low earnings multiple. Organic revenue growth in the second half of the year to end March is expected to have come in at an uninspiring 2.5 per cent, and that is before the negative impact of discontinued engineering contracting activities. What’s more, cash flow is expected to suffer as the number of so-called “bundled service” contracts that Mitie delivers increase. These contracts - where, for example, Mitie might supply lots of services from fixing the roofs to cleaning the windows for a local authority - demand high set-up costs, which takes its toll on cash. But the pay-off is that they provide secure long-term revenues. Further uncertainty is added into the mix by Mitie's negotiations with the Cabinet Office about how to reduce the cost of its existing public-sector contracts, much like the process that the likes of Serco and G4S have had to go through.

Given these issues, it is hardly surprising that the share price has been weak, even though the group’s long-term track record is impressive. With the failure of fallen support-services stars Connaught and Rok still fresh in investors' minds, since the start of the year Mitie’s shares are down by 16 per cent, compared with a 2 per cent rise from the FTSE All-Share index.

However, despite the expectation of disappointing organic sales growth, improvements to profit margins should lessen the impact on profits, which are expected to hit City forecasts (see table). What’s more, recent acquisitions will help bolster the result for 2011-12. And, with a £100m placement of loan notes recently completed and a robust balance sheet, acquisitions remain on the cards, especially to bolster Mitie’s forays into overseas markets.

The move overseas is one reason to hope for revived growth from Mitie. The group is predominantly UK focused, but has been making efforts to follow private-sector clients abroad. For example, it extended a contract with Rolls-Royce last year, which has seen it take on work in Norway, Finland, Sweden, Germany, France and Poland.

However, the real boon for the group could be increased public sector outsourcing in the UK. True, this market has been dull following changes announced by the coalition government. But, there is a widespread assumption that increased outsourcing will be a key way in which savings to public-sector spending are realised. Mitie's bosses say this trend is already evident in the group's "growing sales pipeline". The move towards bundled contracts, while an upfront drain on cash, also presents an opportunity because only the bigger players, such as Mitie, have the resources to offer central and local government a package of several related services.