Serco, so good

International service company Serco Group (LSE: SRP) has done far better with its share price, up 37% in the last 12 months. It’s up another 4% today after its trading update for the first half of 2019 showed 20% growth in underlying trading profit and 6% for revenues.

Serco also reported a £3bn order intake, including the award of its largest-ever contract, with AASC. 2019 will be the third year in a row in which order intake exceeds revenues.

Top end

The share price also benefited as it reported FY19 revenue is expected to be around the top end of the previously-stated range of £2.9-3bn, while underlying trading profit guidance was maintained at around £105m.

Group CEO Rupert Soames said the £1.73bn FTSE 250 company enjoys the “strategic advantage of having a strong international footprint” with 4% organic growth driven by the Americas and Asia Pacific divisions. Its UK division posted an improved trading performance, boosted by the Carillion health facilities management acquisition completed in 2018.

Fighting back

There’s one “but” though. When Rupert Hargreaves looked at Serco stock in February, he concluded it was too expensive, trading at a vastly optimistic forward P/E of 19.9, and feared that even a slight disappointment in earnings could punish the share price. Now it trades at a whopping 24.8 times earnings, making it even more expensive.

Soames has done a great job of turning Serco around since his appointment five years ago, when the group was struggling. He’s returned the company to growth and driven through plenty of M&A activity, and deserves plaudits. The downside is that it looks a bit pricey, plus there’s no dividend.

Liontrust roars

Fund manager Liontrust Asset Management (LSE: LIO) has also had a good spell, its stock up 26% in the past six months. But it’s flat today despite impressive final results showing a 10% rise in adjusted profit before tax to £30.1m and record inflows of nearly £1.8bn.

Revenues also rose 10% to £85m while profit before tax rose a bumper 55% to £19m, helped by a £4m drop in costs to £11.1m. Record net inflows for the year to 31 March totalled £1.78m, up from just over £1bn last year, particularly impressive given recent market bumpiness. CEO John Ions said “a 21% increase in assets under management emphasise another successful year for Liontrust.”

He pinned this success on building an impressive group of investment teams, along with “a great distribution franchise and a strong and distinctive brand.” Lionstust has always been respected by the brokers I talk to (mind you, so was Neil Woodford). 

Watch it

The share price is a bit less toppy than Serco’s at 13.5 times earnings and investors get a 3% yield and a progressive management attitude as well, with the total dividend per share lifted 27%.

Edward Sheldon also rates this small-cap champion, whose market-cap is just £367m. He even suggests it could be a takeover target. Fund managers are highly exposed to stock market fortunes. Maybe one to stick on your watch list for the next dip?

The post One FTSE 250 stock and one small-cap I’d consider buying with £2,000 appeared first on The Twelfth Magpie.

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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Indeed, over the past six years, the retailer’s normalised earnings per share, which exclude the impacts of one-off costs such as restructuring charges, have increased by just 4p, from 35p to 39p. 

Performance on the top line hasn’t been much better. For 2013, the group reported revenues of £10bn. Analysts have pencilled in sales of £10.4bn for fiscal 2019, an increase of £400m, or less than 1% per annum.

Standing still

The City doesn’t expect Marks’ outlook to improve anytime soon. Analysts have pencilled in a net profit of £403m for fiscal 2019, around 10% less than the figure reported for 2013, which seems to confirm my suspicion that the retailer’s growth days are now behind it.

Recent speculation that M&S might be pursuing a tie-up with online delivery giant Ocado, isn’t enough to change my views on the business. 

Marks has carved out a niche for itself in the grocery market, but the core business, clothing, is really struggling and I just don’t see growth improving here anytime soon. Efforts to make a brand more appealing to a younger demographic seem to have only have alienated the brand’s most loyal customers. Meanwhile, online fast fashion houses such as Asos and Boohoo are proving to be relentless in their quest to take over the UK clothing market.

Full valuation 

Having said all of the above, I’m not predicting the demise of the business anytime soon — more than £10bn in annual sales is still enough to make M&S one of the UK’s top retailers. However, as an investment, I think investors should probably stay away. 

A dividend yield of 6.5% might look attractive but, in my view, the stock is fully valued trading at 11.8 times forward earnings. With no return to growth on the horizon, I’m struggling to see any upside for the shares at the current valuation.

Overvalued 

Another overvalued business that I’m staying away from it is outsourcing group Serco (LSE: SRP), which is expected to return to growth in 2019 after four years of restructuring.

After flirting with bankruptcy in 2015, management has been working flat-out ever since to put the business back on a stable footing, win contracts, and return to growth.

So far, everything seems to be going to plan. The City is expecting Serco to report a net profit of £54m in 2018, the first full year profits since 2013. And 2019 is also expected to be another profitable year. A £560m contract with Bupa to help provide medical services to the Commonwealth of Australia’s Department of Defence — announced today — will help profits grow.

Nevertheless, despite Serco’s improving outlook, I’m not a buyer. Looking at it right now, I think the stock’s biggest problem is its valuation. It’s trading at a forward P/E of 19.9, which seems vastly over-optimistic. At this level, even a slight reduction in earnings expectations could lead to a substantial decline in the share price. Considering the company’s history, I’m not willing to take that risk.

The post Why I’m staying away from the Marks and Spencer share price appeared first on The Twelfth Magpie.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK owns shares of and has recommended ASOS. The Motley Fool UK has recommended boohoo group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Full-year results are due on 22 February, and according to December’s update they should be better than previously expected. Profit should be towards the top end of guidance, with net debt towards the lower end. The firm expects to report an order intake of more than £3bn, and the key thing for me is that “strong profit growth” is on the cards for 2018 and 2019.

The move back to growth got an extra boost Wednesday, as the firm updated us on its planned acquisition of a portfolio of health facilities management contracts from failed Carillion.

Cheaper acquisition

The deal has been revised, and should all of the planned contracts be transferred to Serco, the total payable would amount to £29.7m. That’s cheaper than the £47.7m initially envisaged in December, and covers “substantially all of the assets” originally targeted.

The lower consideration is due to “Serco’s re-evaluation of potential liabilities, indemnities, warranties and the additional working capital investment required as a result of Carillion’s liquidation.” But expected revenues are unchanged — estimated at around £90m annually.

The mooted 2017 earnings fall puts the shares on a P/E of over 30 at today’s price of 84p, but two years of forecast growth would drop that to under 19 by 2019. That’s still a bit heady, but I can see the start of a solid recovery — and a decent long-term buy.

Depressed favourite

AA (LSE: AA) shares have lost over 70% of their value since a peak of more than 430p in March 2015. We’re looking at just 115p today, giving us a very low P/E of just 5.5 based on expectations for the year ended January 2017 — and that would drop as low as 4.8 on 2019 forecasts.

Earnings are expected to turn upwards this year, and there are well-covered dividends yielding better than 5% on the cards. And last week’s pre-close update looked promising.

The big problem for AA is the debt that it has been saddled with since flotation in 2014. The company did refinance some of it in July 2017, but at the halfway stage it stood at almost £2.7bn.

That was slightly down on the £2.8bn level a year previously, but I don’t see any signs of a serious reduction. To put it into perspective, the market capitalisation of the company stands at just £700m — and debt of £2.7bn is almost eight times the company’s expected EBITDA for the current year.

New cash?

That’s massive debt by any standards, and the big question is whether it’s sustainable without turning to a new equity issue to raise more cash. I have my doubts, and I really do think some sort of cash injection will be needed.

Despite these problems, Neil Woodford holds AA as an income stock. And though there is clearly risk here, I don’t see a great danger to the thrice-covered dividend (the cost of which is tiny compared to the debt, so suspending it wouldn’t help).

At super-low P/E levels, I see too much fear built into the price, and I’d be tempted.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Made to order

Serco’s closing net debt is expected to be towards the lower end of the previous guidance range of £150m to £200m, which makes a killer combination. Management also reported a strong order intake of over £3bn, which represents a book-to-bill ratio of over 100%, its first since 2012. It anticipates strong profit growth in both 2018 and 2019, with growth thereafter dependent on market demand reverting to trend.

The £1.14bn group’s order intake includes Grafton prison in Australia, its largest ever win, as well as other new contracts for Southampton NHS Foundation Trust, the US Army Installation Management Command and the US Navy Fleet Readiness Centers, among others.

Pipeline pain

Revenue for 2017 should come in at just under £3bn, a small reduction against previous revenue guidance, largely due to adverse currency movements and other volume and timing effects. Management also warned that some markets, particularly the UK, are growing more slowly although it can partly compensate by cutting costs.

Investors in this former falling knife deserve some respite as Serco’s share price is trading 78% lower than five years ago, with profit warnings in 2014 and 2015 hitting it hard. Its stock suffered again in November when it withdrew bids for light-rail franchises in the Middle East, shrinking its bid pipeline of large contracts by almost a third.

Cry babies

Serco’s fightback has a long way to go still, given disappointing free cash flow, no dividend and continuing debt, with City analysts forecasting a 63% drop in earnings per share (EPS) this year, followed by a 37% rebound in 2018. However, long-term investors may benefit from investing ahead of the recovery although some may prefer these two bargain stocks that could make you rich.

While Serco is generating excitement today, I suspect the glory days may be over for fashion e-commerce leader Boohoo.Com (LSE: BOO). Its stock is up an incredible 403% over the past two years but its share price has fallen more than 30% in the last three months.

Pretty vacant

What comes up also goes down, often at a similar speed, and with the stock currently trading at a whopping 78.8 times earnings, that time could be now. There is nothing particularly wrong with the underlying business, which has supplemented its range of brands with acquisitions PrettyLittleThing and Nasty Gal, simply that market expectations have become overstretched.

EPS growth of 48% in 2016 and 97% in 2017 are forecast to modify slightly to 27% and 28% over the next couple of years, which is still growth to die for, but maybe not at today’s valuation. Last time I looked at the stock, in September, it was trading at a whopping 113 times earnings and I am glad I urged caution given its subsequent plunge. Sometimes you have to admit you have come to the party too late. With Serco, the party may just be getting started.

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Embattled outsourcer Serco (LSE: SRP) had some good news for investors today. The company, which has been undergoing a restructuring for around three years, announced this morning that it had signed heads of terms to acquire a portfolio of “selected UK health facilities management contracts” from Carillion, for a total consideration of £50m. 

Also, the company told investors today that it has spent £15m to acquire US defence engineering firm BTP Systems. The deal is set to complete “around the end of next year” while the healthcare contract is expected to be fully integrated by the end of 2018 too. The healthcare deal will produce estimated annual revenue of approximately £90m for more than a decade. 

A turning point 

The fact that Serco has started to do deals again marks a turning point for the struggling business. Indeed, after three years of falling profits and revenues, this year City analysts are expecting the company to report a robust recovery in pre-tax profit. 

A figure of £55m has been pencilled in, up 83% year-on-year on revenues of £3.07bn, up 2%. 

I believe that this return to growth will result in a higher dividend for investors. Serco slashed its payout in 2013, from 10p per share to 2.5p before eliminating it entirely. Analysts are expecting a token distribution of 0.13p this year rising to 0.4p for 2018. 

After this growth of 200%, there is scope for further payout increases as earnings continue to expand. Based on current projections, the payout will be covered 10 times by earnings per share for 2018. Historically, Serco has paid out around one-third of earnings to investors via dividends. As revenues stabilise, I expect management to re-adopt this strategy. 

According to my figures, paying out one-third of earnings for 2018 would give a total dividend of 1.2p per share, up 900% from current levels. 

Dividend champion 

Growth at Secure Trust Bank (LSE: STB) has been nothing short of exceptional over the past five years. Revenue has expanded from £47m to an estimated £138m for this year and if the company hits City analysts’ estimates for growth, by 2018 earnings per share will have doubled in the space of seven years. 

However, despite this growth, the company remains unloved by the market. The shares support a dividend yield of 4.5% and only trade at a forward P/E of 12.9, falling to 9.9 for 2018. 

If the company can repeat its performance of the past five years, I believe that there’s scope for both the shares and dividend to double. Doubling earnings per share to 300p or more by 2025, and assuming the earnings multiple remained the same, would give a share price of 3,600p, a return of 10.4% per annum. This excludes and dividend payments. 

Right now the company distributes 60% of earnings to investors via dividends. Some 60% of 300p would give a dividend payout of 180p per share, up 125% from current levels, providing a yield of 10% at current prices. 

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Strong demand

However, the operational and share price momentum seems so strong that I reckon there could be more to come for investors. Today’s half-year results underpin the argument, with the directors saying they expect demand to remain strong through the second half of 2017 with production marginally ahead of the first half.

The figures are robust with revenue ballooning 29% compared to the equivalent period a year ago, net cash from operations shooting up 37% and net debt down by 36% to US $481m, which is around twice the level of the firm’s pre-tax profit for 2016 and the lowest since 2012.

Cyclicality and growth

As you might expect, the price of iron ore has been trending upwards since this dramatic reversal in Ferrexpo’s fortunes, but it is pleasing to see the firm paying down its debt while the economic sun is shining.  Yet I think it would be unfair to suggest that the company is merely a cyclical leaf being blown around by winds of sentiment and macroeconomics. There’s a big element of that, of course, but it also claims to be managing costs and increasing levels of capital investment to grow output. As well as cyclicality, there’s growth here.

I’m less enamoured with public services provider Serco Group (LSE: SRP), which also released its half-year results this morning. The shares are up almost 3% as I write and chief executive Rupert Soames reckons first-half trading shows an improvement in underlying trading profit compared to the second half of 2016, keeping the company on course to meet the directors’ expectations for the full year.

Wiggly earnings

City analysts following the firm predict a 61% decline in earnings for 2017 compared to 2016 and a partial recovery as earnings rebound by 35% during 2018. However, the firm’s record of trading shows earnings as likely to fall as they are to rise over the past five years and I’m not willing to bet that the firm can ever fully recover from its operational problems and catastrophic profit collapse around 2014.

That said, the top executive is clear that the firm’s order intake has been strong for “two successive periods” totalling around £4bn in the last 12 months. However, he goes on to admit that the directors remain cautious because the political environment in several of the company’s markets is more and more unpredictable.

In many ways, I see the firm’s fortunes as largely outside its own control because a change in government policy could potentially pull the rug from forward earnings at any time, therefore I’m avoiding the shares even as a potential recovery play.

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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Former FTSE 100 member Serco Group (LSE: SRP) is a good example. It announced a £1.5bn contract this morning to run what will become Australia’s largest prison. Operations won’t start until 2020, but this 20-year contract is the kind of long-term deal that chief executive Rupert Soames hopes will attract investors.

Mr Soames has done a good job of stabilising the business and Serco’s latest results showed an improvement in underlying earnings and revenue. But the group’s profit margins remain very much lower than they used to be. In 2012, the company reported an adjusted operating margin of 6.4% on turnover of £4.9bn. Last year, the equivalent figures were 2.7% and £3bn. Adjusted operating profit has fallen from £314.8m in 2012 to just £82.1m last year.

The company is expected to achieve adjusted earnings of 2.7p per share in 2017, rising by 33% to 3.5p per share in 2018. But even using next year’s earnings, the shares still have a hefty forecast P/E of 33 and a prospective dividend yield of just 0.4%.

If Serco can rebuild its profit margins, then earnings could rise rapidly and the stock could look cheap at current levels. But the outsourcing sector is under a lot of cost pressure at the moment. The firm’s guidance suggests to me that it could be several years before margins improve.

Although I believe Serco does have the potential to deliver a strong recovery, I think this may take longer than expected. I’m not convinced the shares are a compelling buy today.

A contrarian buy?

Small-cap stocks aren’t always very closely followed by City analysts and fund managers. As a result, they can sometimes offer much greater value for investors who are willing to do their own research.

One potential value pick that’s appeared on my radar is agricultural feed and fuel supplier NWF Group (LSE: NWF). This business has grown steadily over the years by buying independent local firms and combining them into a larger group, with significant cost savings.

However, demand for the firm’s products fluctuates depending on weather conditions and commodity prices. It’s also a very low-margin business, with a five-year average operating margin of about 1.5%.

NWF had a slow start to last year, and the shares have fallen by 23% so far in 2017. However, today’s year-end trading update confirms that trading conditions have improved as the year progressed. Results for the year ended 31 May 2017 are expected to be in line with market expectations.

That leaves the stock looking fairly cheap, on a forecast P/E of 9.9 and with a prospective yield of 4.4%. Although the group’s growth prospects are probably limited, today’s update confirms that infrastructure upgrades last year have now been completed and may help to provide incremental growth opportunities.

Last year saw heavy investment, which has limited the group’s ability to generate free cash flow. But historically NWF has been strongly cash generative and operated with low levels of debt. This could be a good, cheap income stock to tuck away for long-term gains.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

The losses were largely caused by one-off costs and the market seemed impressed with the underlying performance at the recovering business.

Adjusted operating profits fell only 13.9% to £82m, after overheads grew and revenues largely remained flat. More importantly, cash generated by operations ballooned from £85.2m to £122.8m and was used to take a chunk out of the debt pile, reducing net debt to £147.2m (FY16: £178.3m). In my opinion, these figures form the best picture of how business is proceeding at Mitie.

The board did not recommend a final dividend, bringing the total dividend for the year to 4p, compared to 12p last year. 

Sliding service shares

The company has reported a string of profit warnings over the last couple of years. On top of that, an accounting review found “material errors” back in May, knocking £50m profit off of 2016/17 results. Advisor KGM said the overstatement was caused by aggressive customer contract accounting compared to sector peers. The balance sheet will also be hit by a writedown of between £40m and £50m.

When combined with a £14m one-off charge in January, these adjustments will significantly impact results and valuations given the group made only £76m last year.  The company has lined up Derek Mapp as the next chairman, alongside new CEO and CFO Phil Bentley and Sandip Mahajan respectively in a bid to turn performance around. 

Mitie has also sold its lossmaking healthcare business in an effort to focus on core, profitable areas. Its strategy is solid, if not compelling, and consists of a focus on culture and advanced technological solutions. The company has also launched a programme dubbed Project Helix that aims to generate £45m in savings a year.

Given the wholesale replacement of management, I’m expecting the kitchen sink to come flying out the HQ window soon, so investors who hold the shares would do well to prepare for writedowns, in my view.

Despite steady trading, I’d avoid Mitie and the entire service sector.  You see, multiple companies will bid for a service contract, resulting in a race to bottom on price and profitability. Often, the job goes to the lowest bidder, resulting in poor services and a disadvantage in the renewal process. This, combined with paper-thin margins and an austerity-focused Tory party puts me off of service companies in general.

Locked into long-term losses

Serco too is on a long and winding road to recovery, according to CEO Rupert Soames. The company has suffered a number of contract issues, scandals and profit warnings in recent years.

Mistakes were made operating the Compass UK asylum seeker support contract alongside G4S. The contracts, which were signed in 2012, have been extended until 2019. Costs have risen far beyond expectations and Serco has been unable to negotiate significant pay increases. When the deal expires, Serco expects to have lost £112m overall.

G4S is set to lose £107m for similar reasons. This contract perfectly demonstrates the dangers of working in a competitive, low-margin industry. Dividend investors would do well avoiding service companies altogether.

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Zach Coffell has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Indeed, the outsourcer model is inherently flawed because these businesses operate with razor-thin profit margins. When bidding on contracts companies usually put in the lowest bid possible to try and win the business, which offloads risk from the seller to the buyer. The combination of these two factors means outsourcers have almost no margin for error when things don’t go to plan.

And the recent performance of shares in Mitie (LSE: MTO), Interserve (LSE: IRV), Capita (LSE: CPI) and Serco (LSE: SRP) is an excellent example of how investors suffer the fallout from outsourcers’ poor business model.

Falling knives

Over the past 12 months, shares in Capita have plunged by more than 49% as the company has issued multiple profit warnings. Shares in Mitie have fallen 29% over the same period, and shares in Interserve are down by 44%. Serco is the only company to have seen a positive share price performance. Since February last year shares in the group have gained 46%. But to put this into some perspective, over the previous five years the shares were down by a staggering 78%.

Not one of these companies has seen a positive share price performance over the previous five years. The best performer among them has been Capita. Since February 2012 the shares are only down by 15% excluding dividends.

These declines have left Serco, Interserve, Mitie and Capital looking relatively attractive on both a valuation and yield basis but considering the sector’s underlying issues, I’m staying away at all costs.

Value traps

Capita is the perfect example of a company that looks cheap but could be a value trap. The shares trade at a forward P/E and support a dividend yield of 6.1%.

Following the company’s numerous profit warnings, management has decided to sell the business’s asset services division, arguably the group’s crown jewel. Proceeds from the sale will be used to reduce debt and fund the dividend. This could be the first of many sales as the company sells off assets to make up for past mistakes and returns cash to investors.

On a historic basis, shares in Mitie support a dividend yield of over 6%, but after the firm’s recent profit warning, management has cut the payout by 40%. Earnings per share are expected to fall 47% for the year ending 31 March 2017 and not return to last year’s level before the end of the decade. Trading at a forward P/E of 17.5, the shares look overvalued.

Shares in Interserve trade at a forward P/E of 5.3 and yield 10.8% but this lofty dividend might not be around for long. Management warned last week that net debt for 2017 would average £450m, 38% above the group’s current market capitalisation of £326m, a big red flag for investors.

After several rocky years, Serco is struggling to get back on track. City analysts expect the firm to report earnings per share of 3.1p this year, indicating the shares are trading at a forward P/E of 54, a high multiple for a struggling business.

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• With a yield of 6.8% and a P/E ratio of 12.1, is this a dirt cheap FTSE 250 stock to consider?
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.