After years of profit warnings and scandal, outsourcers have finally been rehabilitated. Covid contracts are long gone, but demand for Mitie (MTO) and Serco (SRP) is still strong, while defence specialist Babcock (BAB) is benefiting from the geopolitical tumult. Profit margins across the sector are also widening despite inflation.
Can the good times continue? Many investors still worry that outsourcers will get embroiled in long, complicated contracts that turn out to be lossmaking. These companies don’t have a lot of room to play with after all: outsourcing is low-margin work and competition is fierce. The risk of losing a big contract also looms large, given that they are constantly rebidding for projects.
However, management teams are hyper-alert to contract risk after the disasters of the 2010s. Meanwhile, margins have proved robust during a time of high inflation, and cash generation is improving. Babcock’s underlying operating cash conversion ratio jumped to 82 per cent from 63 per cent in the six months to September, and it paid its first dividend in four years this month. Serco is even better at converting profit into cash, and Mitie is rapidly improving. It reported a free cash inflow of £48mn in September compared with an outflow of £5mn in 2022.
The demand outlook varies slightly from business to business. Mitie’s total order book is up year on year and its book to bill ratio – which measures how well new orders compare with previous sales – stands at 111 per cent. Babcock is also targeting more organic growth, as defence remains high on the agenda. By contrast, Serco is cautious, saying 2024 revenue will be similar to 2023 and that organic sales will dip by 3 per cent.
Ultimately, all three companies seem to be on considerably more stable footing and profitability is improving against a tough backdrop of competition and wage inflation.
| NAME | Price (p) | Market cap (£mn) | 12-month (%) | Fwd PE | Yield (%) | Last IC view |
| Babcock International | 451 | 2,288 | 48 | 11 | 0.0 | Hold, 411p, 14 Nov 2023 |
| Mitie | 105 | 1,339 | 31 | 10 | 3.5 | Buy, 106p, 23 Nov 2023 |
| Serco | 175 | 1,912 | 16.7 | 11 | 1.8 | Buy, 158p, 3 Aug 2023 |
