After the public relations disaster of 2013 - scandals included overcharging for prisoner tagging and issues over contracts for the management of court buildings - outsourcers spent last year licking their wounds and reviewing business practices. The results have been mixed.
Serco Group (SRP) continued to struggle the most. In May - after two profit warnings - Rupert Soames, formerly of Aggreko (AGK), was appointed chief executive, charged with leading the group's turnaround. The move was clearly a popular one with investors, as the shares rose 4 per cent on the news. But Mr Soames' investigation into the company's strategy and historical contracts threw up some troublesome results, prompting a third, kitchen-sinking profit warning in November. The update included increased charges for impairments against contracts won on wafer-thin margins, as well as restructuring measures for parts of the business that had become dysfunctional. The total bill came to a massive £1.5bn.
There was some good news at the tail end of 2014 when the police decided to drop its investigation into the prisoner-escort contract. The group also managed to renegotiate financial covenants with its lenders, paving the way for a £550m rights issue expected during the first quarter of this year.
Rival outsourcer G4S (GFS) had more success last year. Although the group is still under investigation over its prisoner-tagging contract, it posted encouraging first-half figures. Organic revenue growth reached 4 per cent, and the absence of large exceptional costs helped lift the group back into pre-tax profit. The group also managed to secure £1.2bn-worth of new contracts, up by a quarter year on year.
Capita (CPI) and Babcock International (BAB) also made progress in 2014. The former headed the FTSE 100 leaderboard after its half-year figures sparked a flurry of broker upgrades. Babcock, meanwhile, benefited from its acquisition of helicopter services business Avincis, which boosted its order book by more than a half to £18.5bn. Its close ties to the Ministry of Defence remain supportive, too: it signed a £2.6bn contract to continue servicing the Clyde and Devonport naval bases in Plymouth until 2020.
Since outsourcers derive much of their revenue from government spending, the UK general election in May is bound to affect the performance of the sector this year. In the short term, a hiatus in the award of contracts seems likely as government departments wait to see who will be their next bosses - and then wait to see what they want. Beyond that, things are far from clear. Labour leader Ed Miliband has set outsourcers in his sights, but has offered no credible alternative to the current system of private contractors working alongside the state. The Tories want outsourcers to help them cut costs - but, as Serco has showed, that can also mean cutting margins.
| Company | Price | Market value | PE ratio | Yield | 1-year performance (%) | Last IC view |
| WS Atkins | 1267 | 1268.4 | 14.1 | 2.7 | -11.27 | |
| Babcock International | 1016 | 5102.32 | 13.8 | 2.16 | -19.19 | |
| Capita | 1105 | 7313.02 | 17.7 | 2.48 | 3.37 | |
| G4S | 283.5 | 4398.77 | 19.2 | 3.16 | 9.33 | |
| Interserve | 511.5 | 736.14 | 9.5 | 4.34 | -24 | |
| Mitie Group | 276 | 1008.21 | 11.1 | 4.09 | -16.21 | |
| Regus | 205.6 | 1928.7 | 29.8 | 1.82 | -5.6 | |
| RPS Group | 198 | 438.27 | 9.6 | 3.98 | -43.64 | |
| Serco Group | 165.9 | 911.23 | 6.7 | 6.36 | -67.69 |
Favourites
The recovery at G4S is underway. Its third-quarter trading update in November revealed that it had won new contracts worth £1.7bn in the year to date, with a 90 per cent retention rate. Trading on about 16 times consensus forecasts for 2014 underlying earnings, the shares are not expensive compared with the support services average of over 20 times. In November we tipped the shares as a buy.
Outsiders
Shares in Serco have tanked over the past 12 months, falling almost 70 per cent to 161p. While the renegotiation of its covenants is reassuring, a return to growth is still a very long way off. The rights issue will be the first real step on the path to recovery.
