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Serco profit boosted by Test & Trace contracts

Almost a fifth of its revenue came from Covid related contracts but the company is confident it can maintain momentum after the pandemic is over.
Serco profit boosted by Test & Trace contracts
  • Efficient billing meant free cash flow was up 61 per cent to £130m
  • Manageable debt gives it headroom for future acquisitions

The outsourcer Serco (SRP) has posted a jump in profits off the back of its Covid Test & Trace contract. Covid-19 related contracts made up 17 per cent of its revenues and contributed to a 31 per cent increase in reported operating profit. The company expects revenues to be lower in the second half of the year, as the Covid effect dissipates, but believes the good will it has built up will stand it in good stead.

Organic revenue for the period was up 15 per cent while total revenue grew 19 per cent. This pandemic induced bump in revenue contributed to a 61 per cent boost to free cash flow. The strong free cash flow performance was also helped by the fact that 89 per cent of UK supplier invoices were paid within 30 days. Proving it can quickly turn billings into cash is essential for convincing the market that a Carillion like bankruptcy is unlikely.

A strong balance sheet also offers protection and Serco's net debt and cash profit are in equilibrium, with the former measure up by £82m compared to last year because of £249m worth of acquisitions. However, its net debt/cash profit ratio is still well below its 3.5 times covenant requirement, meaning it has plenty of headroom for future acquisitions.

Since it tried to acquire Babcock (BAB) in 2019, it has shown appetite for deals and the acquisition of US defence business Whitney, Bradley & Brown in February looks shrewd. The US defence budget is unlikely to be cut and President has just asked for a $10bn increase to $715bn for the 2022 budget. This makes the US government a reliable customer.

Serco is currently trading at a 12 month forward PE ratio of 13.9 compared to 4.4 for rival Capita (CPI), according to FactSet broker consensus. This is justified given Capita’s net debt to cash profit ratio is three times higher and that Serco was the go-to contractor during the Covid crisis. The Financial Times reported that Serco secured £157m of UK government contracts between February 1 and September 7 last year, the most of any outsourcer.

The only concern is that revenues linked to the virus may slow in the second half of the year. However, Serco is confident it will be offset by stronger performance from businesses that were negatively impacted by the pandemic like UK Leisure, Health and Transport. Buy.

Last IC view: Buy, 136p, 25 Feb 2021

SERCO (SRP)    
ORD PRICE:140pMARKET VALUE:£ 1.70bn
TOUCH:140-140.3p12-MONTH HIGH:172pLOW: 106p
DIVIDEND YIELD:1.6%PE RATIO:6
NET ASSET VALUE:76p*NET DEBT:70%
Half-year to 30 JunTurnover (£bn)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
20201.8276.45.74nil
20212.1710419.10.80
% change+19+36+232-
Ex-div:16 Sep   
Payment:12 Oct   
*Includes intangible assets of £986m or 81p a share.