Why I’d Dump Serco Group plc As It Surges 10%+ & Buy G4S plc Or Capita PLC Today

Serco Group plc (LON:SRP), G4S plc (LON:G4S) and Capita PLC (LON:CPI) are under the spotlight.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The trading update released today by Serco (LSE: SRP) did little to convince me that its stock is a fair buy at this price, in spite of a 14% surge in early trade. In fact, I’d rather choose G4S (LSE: GFS) or Capita (LSE: CPI) if I were to invest in the outsourcing sector. Here’s why. 

Distressed Asset

warned in June 2014 about the perils of investing in Serco, and ever since the stock has lost 60% of value. It currently trades at 130p but I am not interested, although opportunistic trades may find a compelling argument to buy into it — a change of ownership, for instance. 

Management said that trading “in the year to date has been a little better” than it anticipated, confirming guidance for the year, according to which revenues will likely to be around £3.5bn, trading profit will hit £90m, while earnings before interests, taxes, depreciation and amortisation is expected to come in at about £160m — these figures are consistent with half-year revenues “of not less than £1.7bn”, and trading profit “of not less than £45m.”

As its restructuring continues, Serco also noted that its indebtedness is going down, and “taking account of other non-trading movements, including cash exceptional costs as previously indicated, net debt at 30 June 2015 is anticipated to be approximately £350m (31 December 2014: £682m).” 

A rights issue has helped it fix its balance sheet, but “free cash outflow for the 2015 financial year as a whole is expected to be approximately £150m.”

I need to see a positive free cash flow yield before suggesting that the business is sustainable. 

G4S & Capita 

G4S is a more valid alternative, although its financial are not completely reassuring and I doubt that capital appreciation will be meaningful over time.

Its stock is up 4.7% over the the last 12 months, while trading multiples based on earnings, cash flow and book value suggest that its stock is fully priced right now. Moreover, a high forward dividend in the region of 3.6% signals risk rather than opportunity, and I am not comfortable with its net leverage position based on its cash flow profile. 

It’s certainly a safer bet than Serco, but it may not be worth the pain, I’d argue — and there are better options, such as Capita, whose stock has risen 7% over the last 12 months and 14% since the turn of the year.  

Its operating and net margin double those of G4S and are also much higher than Serco’s, which is one element I like, while its net leverage is more manageable, and that is reflected in a lower dividend yield, which stands at 2.6% on a forward basis. 

Trading multiples do not point to a bargain trade, though, and that’s one of the reasons why I’d probably look elsewhere for value. 

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.

Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has recommended shares in HSBC and Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Young Asian man drinking coffee at home and looking at his phone
Investing Articles

Here’s how I’d target £496k in FTSE 100 shares and £19k of passive income in a Stocks & Shares ISA

I invest as much surplus cash as I can at the end of the month in my Stocks and Shares…

Read more »

Young Asian man drinking coffee at home and looking at his phone
Investing Articles

Is Rolls-Royce’s share price an irresistible bargain?

Is Rolls-Royce's share price the FTSE 100's greatest bargain today? Royston Wild explains why he would -- and wouldn't --…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

Is the Vodafone share price a wonderful bargain or a horrible value trap?

As the Vodafone share price continues to fall, is it now a stock to buy with a view to a…

Read more »

Hand of a mature man opening a safety deposit box.
Investing Articles

I’d buy 95,239 shares of this banking stock to generate £200 of monthly passive income

Muhammad Cheema takes a look at how Lloyds shares, with a dividend yield of 5.9%, can generate a healthy monthly…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

Can FY results give the Antofagasta share price a long-term boost?

The Antofagasta share price has had a good five years. Now the company says it's set to enter a new…

Read more »

Person holding magnifying glass over important document, reading the small print
Dividend Shares

Can I make sustainable passive income from share buybacks?

Jon Smith notes the rise in share buybacks from FTSE 100 companies, but flags up why they aren't great for…

Read more »

Front view of a mixed-race couple walking past a shop window and looking in.
Investing Articles

After the Currys share price rockets, here are more potential UK takeover targets!

The Currys share price has surged 39% higher in response to news of a takeover bid. Which UK stocks could…

Read more »

Investing Articles

Down 25%, where will the British American Tobacco share price go next?

The British American Tobacco share price has taken a hit. But this Fool isn't deterred. He think's now could be…

Read more »