MOUCHEL GROUP (MCHL)

Last August, Mouchel bolstered its prospects with the £46m acquisition of HBS, an IT and business process outsourcing (BPO) company. That provided Mouchel's government and business services division with increased scale and a wider range of services. That's an important step for the group because its clients, mainly local authorities, are increasingly looking for companies that can offer a one-stop-shop outsourcing solution known as a "bundled services" contract. In fact, before the acquisition Mouchel had already worked with HBS to win a £300m 12-year bundled services contract with Oldham Strategic Services Partnership.

HBS also takes Mouchel into potentially higher-margin segments, which are dominated by companies like Capita that command ratings of over 20 times forecast earnings. Those lofty ratings reflect the expectation that the BPO market, which is estimated to be worth £4bn a year in the UK, will continue to achieve 10 per cent growth a year, providing enormous opportunities for the top operators.

HBS was loss-making when Mouchel bought it but it's being turned around. What's more, Mouchel expects to cut £2.5m worth of costs and the deal is expected to be earnings enhancing by 2009. And while operating margins are expected to drop to about 6.5 per cent this year, they should tick-up to around 7 per cent the year after, with further scope to grow beyond that. Moreover, HBS's losses this year will be partially offset by three small earnings-enhancing acquisitions made in November 2006.

But the attractions of Mouchel extend beyond the acquisitions. As well as its government and business services division, it operates in the highways market and regulated industries. And a number of big contracts could soon be making their way from its £2.6bn bid pipeline onto its £2bn order book. The most exciting prospect comes from two major highways contracts that it's bidding for through a joint venture with Accord. Mouchel has been rumoured in the trade press to be close to winning one of these in the south east, its share of which would be worth about £30m a year.

Other big chunks of work that could be coming the group's way include three new bundled services contracts, possible extensions to its Oldham and Lincoln contracts and a Hackney Building Schools for the Future contract for which Mouchel is preferred bidder. Encouragingly, the group has a strong record of turning bids into business and last year was at the top end of its target range of winning 33 to 40 per cent of bids.

Mouchel's attempts to win business in its rail unit have not been so successful. Still, that shouldn't rattle investors too much because the business, as a whole, does boast good earnings visibility. In fact, according broker Merrill Lynch, 79 per cent of all revenues expected in Mouchel's 2008 financial year are now contracted and so are 60 per cent of revenues for 2009. What's more, about 62 per cent of revenue comes from the public sector with the rest coming from other defensively placed bodies, such as utility companies and Network Rail.

In acknowledgement of its virtues, HBS has been good news for Mouchel's shares. However, given the excellent growth prospects and HBS's ability to create value, the shares aren't demandingly rated. So, with 2008 looking set to be a great year for Mouchel, buy.

BULL POINTS:

• HBS acquisition boosts prospects

• Strong bid pipeline

• Defensive end markets

• Excellent earnings visibility

BEAR POINTS:

• Dull trading in rail division

• Fall in margins expected this year