Should I Buy Serco Group?
LONDON -- I'm window-shopping for shares again, and there are plenty of goodies for sale. Should I pop Serco Group into my basket?
Prisons and hospital outsourcing company Serco Group is on a roll right now. Its share price is up 10% in the last month, after it reported a 27% rise in full-year profits for 2012 to 302 million pounds. The market understandably likes this stock right now. Should I buy it?
Recent performance is particularly impressive, because I would have expected Serco Group to struggle at the moment. It does a lot of outsourcing for the public sector, both in the U.K. and U.S., and with government budgets under pressure, its bottom line should be under pressure. It was certainly squeezed in the U.S., which makes up 20% of its sales, where federal government spending cuts knocked 14% off organic revenues. Serco more than offset these losses by winning a record 5.8 billion pounds of new global contracts, while its order book rose nearly 7% to 19.1 billion pounds. Group revenue rose 5.7% to around 4.9 billion pounds. The dividend was lifted 20% to 10.10 pence. Investors were understandably happy.
I'm happy to see that Serco generates more than 45% of total group revenue outside the U.K., up from 40% in 2011. Its Australasian, Middle Eastern, Asian, and African operations posted organic growth of 22% last year, as management seeks superior growth prospects and wider margins in emerging markets. This also helps offset political risk in the U.K. While Serco has benefited from the coalition's welfare reforms, it constantly risks political backlash. In 2011, it was pilloried for driving prisoners to court in black cabs, while last month, the National Audit Office recently accused Serco of fiddling figures to hit performance targets at its out-of-hours GP service in Cornwall. Given the political dangers and shrinking public sector budgets, I'm glad to see Serco looking farther afield.
With a 31 billion-pound pipeline of new projects, management has good reason to be confident about the future. The board is even bullish about the U.S. opportunities, although it did warn that investors should only expect "modest improvement" in organic growth this year. On a current yield of 1.7%, some investors may be hoping for more income (others will be glad to see Serco plough the money back into its business). But the recent 20% hike, covered a generous 4.2 times, suggests there is scope for further dividend growth as profits rise.
Watch and wait
Forecast earnings-per-share growth of 2% this year is disappointing, although it should rally to 10% in 2014. Revenues are expected to grow from 4.91 billion pounds in 2012 to 5.17 billion pounds this year and 5.47 billion pounds in 2014. Broker views are mixed. Credit Suisse is neutral, but JP Morgan Cazenove is overweight, and Liberum Capital and Espirito Santo both hail Serco a buy, the latter with a 7.10 pound target price. This stock looks pretty fairly valued at 14.4 times earnings. Definitely one to add to your watchlist, if markets fall a little more.
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