Serco - Churchillian resolve needed by all

Serco Group: This is going to be a long haul stock. The still fairly new CEO, Rupert Soames, has taken the chance to clear the decks and get fresh equity on board, ready for the voyage. The final dividend has been passed and there will be no dividend in FY2015 (and maybe a token final in FY2016?), but the stock still has interest as a fallen angel. The key takeaway from the strategic review is that Serco will focus on the Business-to-Government sector across specific sectors and geographies, which look set for structural global growth as governments seek to control costs and improve efficiencies. The key for Serco (and others) is to avoid previous top-line obsessions and make sure that contracts are profitable and well constructed.

In these red-inked results to 31^st December 2014, revenue was down 7.7% at £3.96bn and a corking £1,317m operating loss. This included £745m of provisions, impairments etc. at the trading line and £661m of exceptional items. Back in November the group suggested that a rights issue of around £555m would be needed and in recent weeks some had suggested that less would be required, leading to a rally in the share price. Low and behold, we now have the full £555m (1 for 1 at 101p). These proceeds will reduce net debt to EBITDA to around 2x, with a medium term range of 1x-2x. It is noticeable that there has been a dramatic loss of contract momentum in the business as the clear out has gone on. Whilst £3.6bn of new contracts were signed (similar to the £3.5bn in 2013) and the order book was £15.8bn, (down slightly on 2013’s £17.1bn), the pipeline of opportunities has shrunk from £12bn to £5bn. Whilst the group has re-iterated its broad guidance for 2015, it has withdrawn guidance for 2016 and beyond until the dust settles. For 2015 eps will be low single digits, but whether that is 3p or 4p, it still leaves a big PE and no yield. With no guidance, estimates for 2016 and beyond are educated guesswork. The nadir for sales is headed for £3bn-£3.5bn, with a post rights EV of some £2bn-£2.2bn, providing some support to the equity.

Strictly speaking this is a stock that holds no interest for equity income investors. However, Rupert Soames has a big fan club after his work at Aggreko. Investors in Serco will need a lot of patience, but as a management/recovery situation it could well be worthy of a nap selection. (Neil Cumming^, 13^th March 2015)

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. www.dividendpower.co.uk or e-mail at info@dividendpower.co.uk  Twitter:  @DividendPower