Secure with Serco

Shares in outsourcing firm Serco have been somewhat ignored during the stock market's cyclically-focused rally. However, a storming set of first-half results from the group underlines its attractions, chief of which is hitting growth rates that a typical cyclical company would currently give its right arm to achieve.

Serco does not do glamorous things - its diverse work ranges from running prisons, to performing back-office IT functions, operating air traffic control towers, training soldiers and running railways. But the revenue and profit these activities generate are dependable, and demand for them is growing.

Revenue growth in the first six months of 2009 was 31 per cent, or 21 per cent excluding the impact of a rise in the value of the dollar, and 11 per cent excluding last year's acquisition of SI International. Meanwhile, adjusted operating profits, excluding currency effects, surged 30 per cent to £100m, aided by an improvement in profit margins of approaching 0.4 of a percentage point. And Serco was busy collecting fodder for further growth in the first half. In fact, during the period it was awarded £2.1bn-worth of new contracts and was appointed preferred bidder on business worth £1.4bn. What's more, the group is seeing plenty of opportunities emerge in both the UK and overseas.

With so much work in the bag, Serco's bosses are confident enough to make some pretty bold statements about the group's future revenue and profit growth. Indeed, they have set a target for 2012 of generating revenues of £5bn and to achieve a profit margin of 6.3 per cent. The margin goal compares with 2008's underlying operating margin 5.3 per cent. The first-half margin improvement was helped by cost savings following the SI acquisition and the 2012 target excludes any effects of currency movements and large acquisitions or disposals.

It's rare to see a company that's prepared to "put it on the line" to such an extent by setting such clear growth targets so far into the future. But Serco's bosses have good grounds for their confidence. At the end of June, the group's order book stood at £16.7bn, but, more importantly, 99 per cent of this year's budgeted revenues are in the bag, as are 86 per cent of 2010's and 72 per cent of 2011's. The impressive visibility reflects the fact that most of the group's contracts are long-term, with typical running times of about 10 years. Meanwhile, the pipeline of bid opportunities stands at £27bn. And management's confidence in Serco's ability to exploit this pipeline is underpinned by the group's record of winning half of the work it bids for and 90 per cent of its contact renewals. The group also has an impressive record of expanding the scope of its existing contracts to get more revenue from them.

In fact, Serco's bidding opportunities may well start to increase. About 90 per cent of Serco's business involves outsourcing work for the public sector and 64 per cent of revenue comes from the UK. Ironically, it is the financial difficulties of Serco's main customer - the UK's state sector - that could see it winning more work. These diffculties mean spending cuts are likely to be on the way, and one way the government believes it can maintain key services while cutting costs is through outsourcing. This is a well-established principle, which gained weight from the 2004 Gershon report into efficiency improvements in the public sector .

But the UK isn't the only market that could see increased growth. Serco's acquisition of SI International gives it a major foothold in the US and Serco now generates almost a quarter of its revenues from the region. True, bedding in acquisitions always brings risks, though Serco's bosses reckon there are costs that can be taken out of SI as they integrate it into the group. Besides, Serco's enlarged presence means it is in a better position to bid for contracts in the US. In addition, outsourcing there is not as developed as it is in the UK so there are hopes the market will grow quickly, especially as the US federal government has debt worries of its own. Serco also has a presence in other promising overseas markets, including Europe, the Middle East and Australia.