Serco prospers in post-pandemic world

Serco (SRP) has allayed fears that it was a one-hit Covid wonder once and for all. Despite some positive signs last year, many worried that the government outsourcer would struggle to replace its lucrative Test & Trace contracts with new work, and these concerns were exacerbated when Serco lost a nuclear submarine contract at the end of 2020. 

However, the company has proved resilient, growing revenues by 2 per cent in 2022 and nudging up its underlying profits. This wasn’t achieved without a bit of help: organic revenue declined by 4 per cent in the period, but a combination of acquisitions and favourable currency movements more than counterbalanced this. Meanwhile, Serco’s core business continued to benefit from growing demand for immigration services, more case management work in the US, and new UK government contracts.

There seem to be plenty more opportunities on the horizon. Serco’s order book is up 8 per cent year on year at £14.8bn, and management is confident that macro trends will keep driving growth. Labour shortages, for example, are expected to make it difficult for governments to recruit and retain staff, which should “put a premium on agility, mobilisation at scale, high productivity and effective management”.

There are a couple of things to keep an eye on. Serco’s book-to-bill ratio – which measures how well new orders compare with previous sales – has fallen to 93 per cent, compared with a five-year average of 112 per cent. Management blamed this on the “lumpy” nature of government contracting. 

Meanwhile, there are £1.5bn-worth of contracts that need to be extended or re-bid for by the end of 2025. Some big jobs, including Serco’s Australian immigration contract, are even coming to an end this year. Analysts at Peel Hunt said the group is “well placed to retain the Australian immigration contract”, but it is impossible to be entirely confident.  

Ultimately, however, Serco seems to have emerged from the pandemic in a significantly stronger position. It has increased revenue by 40 per cent since Covid struck, and almost doubled its underlying trading profit to £237mn. Growth is expected to slow down significantly from now on, of course: revenue and underlying trading profit are expected to be pretty flat in 2023, and management expects to grow revenues at an average of 4-6 per cent a year over the medium term.

But demand for its services is strong, past scandals have been resolved, and shareholders are feeling the benefit: management has just announced a £90mn share buyback for 2023, following a £90mn buyback last year. Buy.

Last IC View: Buy, 190p, 4 Aug 2022