Serco surmounts loss of Covid contracts

Serco (SRP) did very well out of the pandemic. Test & Trace contracts accelerated its sales growth, and the group became governments’ go-to outsourcer during the crisis.

The big concern for investors was that Serco’s success would fizzle out as Covid contracts came to an end. These fears have proved largely unfounded, however. The outsourcer has maintained revenues year on year – despite losing £220mn from the wind-down of Test & Trace – and grew its ‘underlying trading profit’ by 6 per cent. (This figure is defined as operating profit minus amortisation of intangibles arising from acquisitions and other exceptional items.)

Demand for case management in North America, employment services in the UK, and immigration services in both Australia and the UK has helped keep business booming.

Admittedly, these figures are bolstered by the acquisition of WBB, a government services provider, last April. Excluding WBB’s contribution, Serco’s sales fell by 3 per cent and underlying operating profit shrunk by 1 per cent. This remains no mean feat, however, given the powerful impact of Covid on 2021 comparatives.

Over the past six months, Serco has also managed to strengthen its balance sheet, reducing debt to £164mn – £61mn less than this time last year. Meanwhile, it has upped its half-year dividend by 18 per cent. 

The next six months could prove trickier. As a result of the recent surge in inflation, the group is increasing pay faster than it budgeted and intends to distribute an additional £9mn in the coming weeks in one-off payments to all staff outside management grades. Pay rises are expected to drive up costs, and drive down profits, in the second half of the year. 

Nevertheless, management has felt able to boost its full-year guidance once again. While organic sales growth is still expected to fall by 5 per cent, Serco's underlying sales profit is now expected to edge up rather than down. The group has also upped its free cash flow prediction, and debt is expected to be lower than previously thought. 

Serco’s shares have risen by more than a third since the start of the year, and the stock has made regular appearances on our ‘Shares hitting highs and lows’ table.  However, its forward PE ratio is still reasonable at 14.5, compared with a five-year average of 18.9, and its order book remains strong at £14.6bn . Buy. 

Last IC View: Buy, 127p, 24 Feb 2022