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

The Daily Telegraph - Business - - Business - Russ Mould is in­vest­ment di­rec­tor at AJ Bell, the stock­bro­ker Read Questor’s rules of in­vest­ment be­fore you fol­low our tips: tele­ questor­rules; twit­

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.

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