Serco is being bolder than most firms and investors should sit up and take notice
Not only has it offered guidance about this year’s profits but it has reinstated its dividends – both promising signs, says Russ Mould
MOST firms are simply unable to provide any sort of guidance on profits this year for entirely understandable reasons: the uncertainty caused by the pandemic and the difficulty involved in judging outcomes from a wide range of possibilities.
It may therefore be worth taking the hint when a company does feel bold enough to stand up, especially when order momentum seems to be gathering. As a result, we are more than happy to stick with Serco, the support services business.
More than three years after our first look in January 2017 identified it as a potential turnaround play, the company seems to be turning into a growth story, helped by a canny acquisition. As part of an unscheduled update last month, Rupert Soames, the chief executive, said first-half trading profits would be
some 50pc higher than a year ago and sales almost a quarter higher (or 14pc on an organic basis).
He said the initial impact of the virus on the firm’s daily operations had been limited, adding that the US Naval Systems operation acquired last year from Alion for $225m (£180m) had continued to bring in plenty of new business.
That meant Serco took £1.8bn of new orders overall in the first half, to enable management to nudge up sales growth estimates for the year, while sticking to guidance for improved profits and lower debt.
There is little for income seekers as yet, although again Serco went against the flow when it reinstated its dividend last year. But if the company can continue to move towards the top end of the 5pc-6pc underlying operating margin range, of which analysts feel the firm is capable, earnings momentum could continue to gather, especially if the sales mix shifts further towards America and the defencerelated businesses.
There are still risks. Serco may be a simpler business than it was but it must still manage large, longterm contracts carefully, as any mistakes could get expensive, while a
substantial portion of group revenues are up for extension or re-tender this year. At least the strong order intake in the first half offers some reassurance on the latter front.
Serco still has plenty of long-term potential. Hold.
Update: DS Smith
John Maynard Keynes, the economist and keen investor, is reported to have once said: “When the facts change, I change my mind.” Although there is debate as to whether he really did offer that pearl, there is even less certainty in this column’s mind that our investment thesis in January last year concerning DS Smith, the packaging firm, is playing out as intended. As a result, it may be time, reluctantly, to fold on the FTSE 100 firm.
Our initial premise was that the stock was too cheap, as it offered exposure to the rise (and rise) of e-commerce and a fat yield while we waited for debt reduction and improved earnings following the £1bn purchase of Europac in 2018.
Although the sale of a non-core plastic packaging business raised cash, helped to rein in borrowing and bolstered DS Smith’s “green” credentials, the rest of the story unfortunately has not moved on in such a convincing fashion (and there is still plenty of debt).
Just under three quarters of sales come from fast-moving consumer goods and the rest from e-commerce and industry. Online shopping has boosted demand for containerboard but weak demand from industrial customers has prompted a slide in overall volumes and the scrapping of the second-half dividend, following April’s cancellation of the interim divi.
While such action is prudent, given the £2.1bn of net debt, it also squashes the argument that the yield can offer support to the shares. A sale locks in a capita l loss of about 6pc but the 16.2p-a-share in dividends leaves us only just short of breakeven. Sell.