Downturn threat obscures outlook for outsourcers

Will more contracts turn bad for the UK's troubled outsourcers?

April 3, 2020

For the UK’s largest outsourcers, many of which have a history of adjusting earnings for impaired contracts and restructuring costs, is the true profitability picture about to become even more obscured by an economic downturn? While Serco (SRP) sees no material threat to the ability of its global government customers to pay the group, chief executive Rupert Soames has conceded that profitability among its 500 contracts this year will be affected, “some up, some down”.

G4S (GFS) has been more sanguine about the impact of Covid-19 on its operations, stating that while uncertainty surrounding its end markets had increased, there had been immaterial financial impact to date. It made no update to financial guidance. However, with over a fifth of revenue coming from cyclical industries, such as retail, leisure and aviation, it is easy to see that earnings could take a turn as a result of disruption for its customers.

For G4S, the risk of a downturn is heightened by the fact it has a large debt pile to service, standing at £2.1bn at the end of December or 2.9 times cash profits. Admittedly, management expects the £670m net cash proceeds from the sale of its Brink’s cash collection business – three-quarters of which are expected by June – to reduce leverage to within the target multiple range of between 2 and 2.5 “over time”. However, any further downturn in profitability could bring it up against the limits of its debt covenants, set at a net debt/cash profit multiple of 3.5. It also has a £411m net pension deficit to contend with.

However, the segment facing the harshest pain in the event of a longer-term downturn is the recruitment industry. As a swathe of companies across different industries have sought to boost their cash reserves, hiring new staff has been one of the first sources of expenditure cuts. Some players within the sector, which is often viewed as a bellwether for the broader economy, have already reported a reduction in fee income within the first few weeks of the virus’s acceleration in Europe.

Hays (HAS) has advised that operating profits will be materially below previous guidance and is readying itself for a more prolonged downturn in client activity by seeking to raise £200m in gross proceeds via a placing. Permanent hiring activity will likely suffer the most in the event European economies enter recession, although Hays earns more than half of its fee income from temporary hires. Rival PageGroup (PAGE) generates a larger proportion of income from permanent hires at between 68 and 88 per cent across its four geographical operating regions.

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