Our piece on the outsourcing sector for this supplement two years ago was entitled “Outsourcers still rebuilding trust”, so it is somewhat surprising to see how little progress – if any – has been made in the intervening years. The last few years haven’t been kind to the sector, but 2018 was the worst yet, with the collapse of Carillion and even Babcock (BAB) – which we have long hailed as being a class apart from its peers – being dragged into the controversy. The question that remains is, can the sector turn itself around?
In fairness to the outsourcing companies, the performance of the sector is not entirely their fault. A report by the House of Commons public affairs committee in 2018 claimed the government had failed in its responsibilities as a client, not appreciating its position as a monopoly buyer and deliberately promoting “an aggressive approach to risk transfer to the private sector”. But with Brexit preparations absorbing the time and brainpower of both Westminster and Whitehall, fundamental reform of the government’s approach looks unlikely in the near term, meaning it is up to the companies to be more selective in their bids.
The self-prescribed medicine looks almost universal: reorienting the businesses away from 'non-core' activities towards specialised higher activities, often with disposals of lower-margin parts of the business, and emphasising the importance of their expertise in technology. Babcock’s chief executive speaks of its “market leadership in technology-based engineering services”, Capita’s (CPI) new strategy increases its focus on “technology-led complex activities” and G4S’s (GFS) chief executive mentions how “combining technology with our established security offering” will strengthen margins and contract retention. This language all sounds positive, but given that shares in all four of the major outsourcers are down over the last 12 months – all but Serco by double-digits – it looks doubtful the market is taking these claims seriously.
Babcock faced a string of controversies in 2018, from the closure of the Appledore shipyard to attacks from a mysterious investment research firm – speculated to be everyone from short sellers to the Russian government – and the £120m restructuring charge following challenges in its oil and gas business. While the group is immune from many of the charges levelled at other outsourcers given the highly specialised nature of its work, as well as its relatively strong margin, many short sellers are convinced the group is heading for another fall.
Short positions against the shares peaked at almost 9 per cent of issued share capital in October last year, but while it came down following the group’s half-year results it has begun to creep up again and sits at 8.2 per cent at the time of writing.
| Name | Price (p) | Market cap (£m) | 12-month change (%) | Trailing PE | Forward PE | Dividend Yield (%) | Last IC View |
| Babcock International | 535.4 | 2,706.96 | -28.71 | 6.4 | 6.5 | 5.56 | Hold, 552p, 21 Nov 2018 |
| Capita | 119.6 | 1,995.43 | -49.52 | 8.8 | 9.6 | 0 | Sell, 144p, 01 Aug 2018 |
| G4S | 205 | 3,180.77 | -28.82 | 11.9 | 10.8 | 4.73 | Hold, 190p, 20 Dec 2018 |
| Serco | 111.4 | 1,223.8 | 13.67 | 21 | 19.8 | 0 | Hold, 113p, 09 Jan 2019 |
