Serco - Not their finest hour......

Serco: A proper big kitchen sink has been delivered by new-ish CEO Rupert Soames, with the shares down at 215p against a high above 600p in 2013. We had all been forewarned of trouble ahead but this is still a very sobering announcement. Their future now is in B2G, which is not a rail company but Soames’ plan to concentrate on Business to Government contracts in areas such as justice, immigration, transport and healthcare. Looking backwards he is flagging £1.5bn of Onerous Contract Provisions, half of which relates to goodwill and intangible assets. They are in talks with their banks about their covenants and the dividend is burnt toast. Following a placing of new shares in May 2014, Serco now plan a £550m rights issue in the first quarter of 2015. They have also flagged that 2014 operating profits should be £130m-£140m, some £20m lower than previously guided. But this may not be the end of it, as the full Strategy Review will not be unveiled until the results update in March 2015. As they say of the Onerous Contract Provisions “the range of possible outcomes is still wide”, with the risk on the upside. Even in this statement they are flagging another £150m-£200m of provisions, relating to UK government work, that they are considering making. Trying to be polite, the professional reputation of former CEO Chris Hyman, on the back of all this, is also toast.

Their main bank covenant is that leverage should be less than 3.5x EBITDA, with the figure being 2.41x at 30^th June 2014 post the equity raise. They now flag that this kitchen sink exercise will sent leverage beyond 3.5x at the December year end. To help get this figure down to a more standard 1-2x, they are flagging the £550m rights issue, but will only launch it once the 2014 accounts are signed off by the auditors. They also warn that trading in 2015 is set to be more difficult than previously expected.

At this stage there are still so many uncertainties that any analyst forecasts are subject to abnormal margins of error. PEs will look huge and the yield is 0%. With no dividend to enjoy, this is clearly not a stock for income growth investors. The reason for flagging it up at all is that Rupert Soames comes with a shiny reputation from Aggreko. A bit of Winston Churchill’s blood in his veins will come in handy too in the long months ahead. Having brought the whole plc down to a solid base by March 2015, Soames will be backed by many a ‘knife-catching’ investor to deliver a meaningful corporate recovery. The underlying opportunities in B2G are attractive and Serco can haul itself off the canvass. (Neil Cumming^, 11^th November 2014)

These comments are not a personal recommendation to deal. Any investments can fall as well as rise in value, so you could get back less than you invest. I may have a financial interest in some of the stocks written about.

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