Serco Group plc Drops 15% As Rights Issue Tests Investor Faith Yet Again

Royston Wild explains why Serco Group plc (LON: SRP) should continue to jangle the nerves well into the future.

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Once again, stakeholders in outsourcing specialists Serco Group (LSE: SRP) are holding their head in their hands in Thursday business.

The company has shed 60% during the course of the past year as a spate of high-profile contract problems has dented investor appetite, and shares were recently down 15.6% today alone as the market digested the latest spate of bad news.

Contract woes smash the bottom line

Serco announced today that revenues slumped to £3.96bn in 2014 from £4.28bn the previous year, the first sales slump for a quarter of a century. This result saw the business swing to an operating loss of £1.32bn versus the £146m profit punched in 2013.

The company has been smacked by a swathe of problems since 2013, which kicked off with tales of Serco charging the UK government for electronically tagging criminals who had left the country; been sent back to prison; or were lying on a mortuary slab.

Consequently, Serco’s battered reputation has resulted in the loss of a number of key contracts as well as a sharp decline in the number of new deals being signed. On top of this, the firm has also had to swallow around £1.5bn of asset write-downs and suck up rising contract costs during 2014.

News of a subsequent rights issue has been on the cards since November’s interims, further testing the resolve of even the most patient of investors. The business plans to raise a colossal £555m to cut its debt pile and get its transformation strategy on track.

A long, treacherous road ahead

Serco again reiterated its plan to reset its operations across five so-called ‘pillars’, namely those of justice and immigration; defence; transport; citizen services; and healthcare. Not surprisingly chief executive Rupert Soames commented that these measures will result in a “tough two or three years of transition.”

This view is shared by the City’s army of analysts, whose forecasts indicate that Serco will clock up a fourth consecutive earnings decline this year, with an eye-watering 42% decline currently pencilled in. And the bad news does not stop there, with an additional 12% slide anticipated for 2016.

These numbers leave the outsourcer changing hands on hugely-unappealing P/E multiples of 25.1 times and 28.9 times prospective earnings for these years, soaring above the value benchmark of 15 times or below. Given the huge amount of heavy lifting Serco’s has to undertake to get back to growth, not to mention its terrifically poor value, I reckon savvy stock pickers should avoid touching the business with a bargepole.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Royston Wild 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.

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