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FTSE 350: Outsourcers making tentative progress

Two years after Carillion's collapse sent shockwaves throughout the industry, the outsourcers may finally be turning a corner
January 30, 2020

Carillion’s dramatic demise two years ago exposed a myriad of unsustainable practices throughout the outsourcing industry. There were fears of a contagion after Interserve became the next domino to fall. Perhaps surprisingly, there have been no further casualties, although the remaining players are in varying states of health. Progress towards a recovery has been mixed, but with some companies finally moving in the right direction, there are potential investment opportunities for those with a healthy appetite for risk.

If the new government boosts public sector spending this could create more work to be outsourced. But a radical shake-up may also be on the horizon, with senior adviser Dominic Cummings having previously written about the “horror” of government procurement. Outsourcers are still working to rehabilitate themselves in the eyes of the public, politicians and investors. They haven’t exactly covered themselves in glory, with a track record of poor project delivery and numerous high-profile scandals. Norway’s sovereign wealth fund divested its stake in G4S (GFS) last year, citing “an unacceptable risk that the company is contributing to systematic human rights violations” in the Middle East. As environmental, social and governance (ESG) investing gains in popularity, the outsourcers could find themselves even more maligned.

Still, some behavioural change has come about as companies attempt to tackle soaring debt, exercise greater bidding discipline to boost margins and map out a path to sustainable growth. The six months to 30 June saw Serco (SRP) achieve organic revenue growth for the first time since 2013. The group is guiding that organic growth will accelerate from 4.2 per cent to 10 per cent in the second half. Now solely focused on public sector work, it is looking to tap into the potential of the US defence sector as the navy there aims to expand its fleet from 280 ships to 355 by 2034. With the $225m (£173m) acquisition of Alion’s Naval Systems Business Unit, defence services now account for around 35 per cent of Serco’s overall revenue. The shares are still some way off their near-400p peak from 2014, but the momentum over the course of 2019 suggests the tide could finally be turning.

Meanwhile Babcock (BAB) is taking advantage of a resurgence in defence spending closer to home. The Royal United Services Institute has hailed the core ministry of defence (MoD) budget (excluding operations) for 2020-21 as the biggest increase in core defence spending since the early 1980s. Last September Babcock signed a £1.25bn contract with the MoD to build five Type 31 frigates from 2021 with revenues and margins from this work expected to ramp up from 2022.

NAMEPrice (p)Market cap (£m)12-month (%)Fwd PEYield (%)Last IC View
Babcock International6193,12813.70%94.90%Buy, 590.6p, 05 Dec 2019
Capita1592,62637.60%12-Sell 137p, 02 Aug 2019
G4S2093,2303.90%114.60%Sell, 195p, 09 Aug 2019
Serco1672,03849.50%24-Hold, 144p, 31 Jul 2019