Serco shrugs off subsiding pandemic contracts

Serco (SRP) managed to deliver consensus-beating sales despite 2021 being the “toughest operational environment” that chief executive Rupert Soames had ever seen, thanks to pandemic-induced labour shortages.

The outsourcing company’s surprise stemmed from its expectation that Covid-related government contracts, such as Test and Trace, would have wound down earlier in the year. 

Instead, pandemic work drove a higher proportion of profits than in 2020, and contributed 15 per cent of total revenues in the year to 31 December. While some of these contracts such as Serco’s work housing UK asylum seekers will take some time to fall back to pre-pandemic levels, they can’t last forever. The outsourcer expects that £60mn of this year’s underlying profits will not recur in 2022, with revenues to fall by 6 per cent to £4.2bn. 

Offsetting this is Serco’s £9.9bn pipeline of new business at the end of 2021, up 50 per cent year on year. A number of contract wins totalling £600mn have also already been announced since the start of 2022, including management of HMP Glen Parva prison, and a contested deal to upgrade missile defence systems for the US Navy.

Broker Numis praised the outsourcing company's “solid growth prospects”, noting that free cash flows rose by 40 per cent to £190mn, providing good headroom for further acquisitions. Serco went on an international shopping spree in 2021, with three acquisitions in Australia, US, and Belgium. Even before acquisitions, the company plans to grow margins to between 5-6 per cent could support more than 70 per cent profit growth over five years from FY22, said the broker.

In the meantime, a new £90mn round of share buybacks should lend support to the shares and help to allay post-pandemic doubts. Buy.

Last IC View: Buy, 140p, 5 Aug 2021

Last IC View: Buy, 140p, 5 August 2021.