Things may be looking up for Serco (SRP) on the back of a Citigroup upgrade and raised full-year expectations, but the outsourcer remains wedded to an industry described as a “national disaster zone” by Labour leader Jeremy Corbyn at the recent party conference in Liverpool.
Socialists have an ideological attachment to municipal public services, but there is reason to think that their criticism of the outsourcing industry resonates with the public at large. The latest British Social Attitudes survey shows that people increasingly want a new spending settlement on public services, presumably at the expense of the private sector, while earlier industry surveys have reflected extreme levels of public opposition to outsourcing in specific areas, namely GP surgeries, court services and emergency services.
That’s a concern for Serco's shareholders, given the group has been heavily involved in all three areas, and has just been awarded a contract by EDF Energy to provide fire and rescue services during the construction phase of Hinkley Point C nuclear power station. However, it’s the involvement of the outsourcing sector in the criminal justice system that seems to draw the most ire. Indeed, the recent public outcry in the wake of an unannounced inspection by HM Inspectorate of Prisons resulted in control of HMP Prison Birmingham being stripped from industry peer G4S (GFS) and returned to the Ministry of Justice. And lest we forget, both G4S and Serco were complicit in a highly publicised (and embarrassing) scandal that saw the government overcharged for the tagging of criminals.
Public attitudes towards the industry soured during the London Olympics in 2012 when the army was forced into civic duty, after G4S failed to supply adequate security cover for the global event. Attempts at rehabilitation, at least in the eyes of the public, have foundered in the intervening period, partly due to the influence of the National Audit Office (NAO), which has repeatedly highlighted failings within the industry, well beyond the usual ‘value for money’ considerations. Earlier this year, the NAO chided NHS England for the failure of a £330m outsourcing programme contracted to Capita (CPI) which had put patients “at serious risk of harm”. That was followed by an estimate from the NAO suggesting that taxpayers were on the hook for around £148m in the aftermath of the Carillion collapse. None of this represents good PR and it emboldens those looking to amass political capital from public dissatisfaction.
Against this unpromising backdrop, Serco has managed to beat expectations for 2018, with underlying trading profit now expected at £90m-£95m, well ahead of the previous estimate of £80m. What’s more, sales are expected to top the range at £2.8bn and accounting net debt is likely to be at the lower end of the £200m-£250m range, where it was previously expected to be at the mid-point or higher.
The upbeat forward estimates also precipitated the third profit upgrade from broker Peel Hunt during 2018, but City analysts are likely to focus more on the group’s ability to morph profits into cash. The cash (Ebitda) margin had edged back up to 1.79 per cent last year, from the 2014 slump that gave way to a negative reading of 24.2 per cent. Peel Hunt anticipates positive free cash-flow in 2019 – albeit with a free cash flow yield of just 0.3 per cent – having previously said it would not happen until 2020. Positive free cash flow could conceivably be followed by a reinstatement of dividend payments, which were scrapped for the 2015 financial year.
