G4S plc (LON: GFS) should outperform Capita PLC (LON: CPI) and Serco Group plc (LON: SRP).
Remember the Olympics? It's less than a year since we were basking in exceptional sporting prowess, our ability to put on a good show, and a parachuting Queen. My sense is that the feel-good factor has pretty much evaporated, along with the supposed boost to the UK economy, but then I'm an old cynic.
One company that will be glad of short memories is G4S (LSE: GFS), the outsourcing company that didn't recruit enough security guards. Last July its CEO was squirming before the Home Affairs committee, the company was threatened with a boycott from the UK public sector, and it pulled out of bidding for the World Cup in Brazil to avoid embarrassment.
But things could now be turning up, putting G4S back on track to continue its growth story.
There has been a spate of good news out of the company over the past couple of months:
- It's reached a financial settlement with the Olympics organising committee. The episode will cost the company £88m, of which £50m has already been provided. That's painful but, like BP's Texan disaster, it's better to have the downside quantified and behind you;
- It's been awarded two UK public sector contracts, demonstrating that it hasn't been blacklisted;
- It has won an offender-tagging contract with the French Ministry of Justice (Jean Valjean, take note), suggesting that foreign government contracts haven't dried up, either;
- It's bought a South African cash-handling business, signalling continued growth in emerging markets, which make up 30% of its revenues;
- Invesco has increased its shareholding to over 15% of the company. Superstar stock-picker Neil Woodford has been a loyal supporter of the company;
- After something of a clear-out of senior management, the company has changed a slew of non-executive directors. In comes Adam Crozier, whose turnaround credentials include the Football Association, the Royal Mail and ITV.
Underpinning G4S's growth prospects are two significant trends:
- UK government outsourcing: Though there wasn't the boom after the coalition's election victory that some expected, and there has been some rowing back since the Olympics debacle, brokers Seymour Pierce calculate that government outsourcing contracts have doubled over the past four years to £20bn, and estimate it could accelerate to a massive £100bn by 2014-15;
- Outsourcing in emerging markets: Last month saw Sao Paulo's regional government launch a road show in London seeking private investors for three prisons. Brazil has the dubious accolade of having the world's fourth largest prison population after the US, China and Russia. Emerging market growth isn't all about Mulberry handbags and iPhones.
Though the Olympics settlement will make the full-year results look ugly next month, these growth prospects should put some fuel under G4S's shares. After losing nearly 20% in the wake of the Olympics, they have clawed their way back to where they were, but have underperformed the sector and the FTSE 100 index.
Three outsourcers, three business models
While G4S's business focuses on areas where security and safety issues are important, rival Capita (LSE: CPI) undertakes more mundane back office outsourcing. That makes it vulnerable to the ultimate cost-saving initiative, offshore outsourcing to places such as India. That's an activity that Capita has been slow to move into. Most of its business is in the UK and growth has come from acquisitions. Though it's set to benefit from a resurgence in public sector outsourcing, its business model makes it a more risky prospect.
Serco (LSE: SRP) is the conglomerate of outsourcing, more diversified in the sectors and activities it engages in, and more geographically spread. Nearly half its business comes from abroad, with the US a significant contributor. Budget uncertainty over there has been a drag on recent performance. Although the company is experiencing fastest growth in its emerging markets business, that's currently only a small part of the mix.
So, to my mind, G4S offers the best prospects. But if you don't fancy the vagaries of the outsourcing sector, you may wish to read this exclusive in-depth report about a different growth opportunity.
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> Tony owns shares in ITV but no other shares mentioned in this article.