One turnaround stock I’d buy and one I’d sell

A painfully slow recovery could mean it’s time to swap this outsourcer for its industry peer.

| 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.

For proof that recoveries can be painfully slow (if they happen at all), look no further than public services company Serco (LSE: SRP). Trading above 500p four years ago, the shares fell as low as 80p last year and, even today, remain stubbornly depressed at 115p.

Given the opportunity cost of remaining invested in an underperforming stock for too long, I’m of the opinion that loyal holders may be better off moving on. Here’s why. 

Outlook unchanged

Today’s pre-close trading update for the first half of the year has been met with a distinct whiff of apathy by the market and it’s not hard to see why.

The outsourcing behemoth now expects revenue to come in at £1.5bn — 8% down when compared to the same period in 2016. At approximately £35m, underlying profit is predicted to be far less than the £51m reported by the company in H1 2016 due to the latter benefitting from what have been labeled as “non-recurring trading items“.

Looking forward, Serco’s guidance for full-year revenue and profit remains the same, at £3.1bn and £65m-£70m respectively. However, the company also stated that the sensitivity of the latter to even small changes in the former (along with costs and currency movements) means that the outcomes for profits “remain wider” than those stated, “both to the upside and the downside“. This lack of clarity is hardly encouraging for investors.

In addition to this, CEO Rupert Soames also stated that a number of the markets in which Serco operates had become “markedly more unpredictable” over the last six months and that management was remaining “sensibly cautious” as a result. That’s despite the company now having what he regards as a “very strong” order intake (around £4bn of business secured over the 12 months to the end of June).

With many obstacles still ahead, horrific free cashflow, no dividend, and levels of debt remaining pretty much the same (at between £150m and £200m), I think there are far better destinations for investors’ capital right now.

Bouncing back

To make things even more painful for Serco, shares in industry peer G4S (LSE: G4S) have been on a roll over the last 12 months. Contract wins with companies including Lloyds and Walmart have seen investors return to the stock in their droves, resulting in a share price climb of 76% and re-admittance to the market’s top tier.

In its most recent update, CEO Ashley Almanza reflected on what had been a “strong start” to 2017 for the company, with last year’s trading momentum persisting into Q1. Revenues from continuing business were almost 9% higher than those seen in the first three months of 2016 with double-digit organic growth being seen in developed markets. A promising pipeline of work now leads management to predict average revenue growth of 4%-6% per annum.

At the time of writing, shares in G4S trade on 18 times forecast earnings with analysts predicting EPS growth of 29% for the current year, falling to 9% in 2018. That doesn’t scream value but it’s a significantly lower valuation than that attached to shares in Serco on a forecast price-to-earnings (P/E) ratio of 43.   

Even with its considerable pensions deficit — which could put pressure on the dividend — G4S looks an odds-on winner when compared to the struggling mid-cap.

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.

Paul Summers has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

How many National Grid shares must I buy for a £100 monthly second income?

I think National Grid could be one of the safest options for investors seeking a dividend income. And today its…

Read more »

Blue NIO sports car in Oslo showroom
Investing Articles

NIO stock is down 90%. Will it recover?

NIO stock has fallen significantly from its 2021 all-time high. But could now be a chance for this Fool to…

Read more »

Smart young brown businesswoman working from home on a laptop
Investing Articles

These 2 UK shares could help me reach £1,000,000 in my Stocks and Shares ISA

A FTSE 100 compounding machine and a FTSE 250 value stock are the UK shares Stephen Wright thinks could help…

Read more »

Middle-aged Caucasian woman deep in thought while looking out of the window
Investing Articles

If I’d invested £1,000 in Lloyds shares at the start of the year, here’s what I’d have now

The stock market is unmoved, but Stephen Wright thinks last year’s record profits might give Lloyds shares a long-term boost.

Read more »

Middle-aged white man wearing glasses, staring into space over the top of his laptop in a coffee shop
Investing Articles

I’ll snap up shares in this growth stock in March if others don’t get there first

This Fool says shares in this growth stock are stable, full of profit, and might be undervalued. But there are…

Read more »

Rainbow foil balloon of the number two on pink background
Investing Articles

My 2 top energy investment trust picks for a passive income

I'm aiming to buy more of these investment trusts for a passive income and the reasonably stable energy sector returns…

Read more »

Storytelling image of a multiethnic senior couple in love - Elderly married couple dating outdoors, love emotions and feelings
Investing Articles

5.5% dividend yield! Shares like these could be great for my retirement

Oliver Rodzianko thinks this company with a stellar dividend yield could be very useful when looking for income from his…

Read more »

Investing Articles

Should I buy this FTSE 250 stock as it soars back to the FTSE 100?

This FTSE 250 stock has rallied following its pandemic woes. This Fool thinks now could be a good time to…

Read more »