More disappointing news flow emerged this week for Serco (LSE: SRP) as it lost out on its lucrative Docklands Light Railway (DLR) contract. It’s a further blow to the company that still appears to be feeling the effects of ‘tag-gate’, where it was forced to repay around £69 million to the government after billing issues meant it had overcharged them. Indeed, the reputational damage from that event seems to still be making life difficult for Serco.
Sitting in the support services sector, Serco’s sector peers range from building supplies companies, such as Travis Perkins (LSE: TPK), to catering companies such as Compass (LSE: CPG) and also includes integrated services companies (provision of facilities management, energy services etc) such as Carillion (LSE: CLLN). Indeed, the sector also offers varying degrees of attraction when it comes to investing, too.
Travis Perkins And Carillion
First, the great investments. Travis Perkins and Carillion currently offer strong potential for buyers, but for different reasons. Travis Perkins offers strong growth potential as a result of increased demand for building supplies, with demand set to increase due to continued improvements in the UK economic outlook and improved prospects for the UK housing market. As such, Travis Perkins is forecast to increase earnings per share (EPS) by 14% this year and by 16% next year. Trading on a price to earnings (P/E) ratio of 14.3, this equates to a price to earnings growth (PEG) ratio of less than 1, which is very attractive.
Meanwhile, Carillion offers a great yield of 5.1% and trades on a P/E of just 10.2. Although Carillion’s bottom-line is set to increase by just 4% in 2015, with the prospects for the UK economy continuing to look brighter, it could be a major beneficiary and, as such, this could act as a catalyst for positive earnings surprises.
Compass And Serco
Now, the not-so-great investments. As mentioned, Serco appears to be suffering from reputational damage in the aftermath of the tagging repayment. Indeed, Serco’s EPS is forecast to fall by 40% this year after falling by 18% over the last two years. Perhaps of greater concern, though, is the uncertainty of Serco’s future profits. If its reputation has been hit, will it be able to win the lucrative contracts that investors had once viewed as the company’s ‘bread and butter’? Or will Serco now struggle to deliver growth over the medium term? Either way, a P/E ratio of 18.6 seems unduly high.
Although Compass Group has a strong track record of earnings growth (EPS growth has averaged 17% per annum over the last five years), the catering company is forecast to disappoint in 2014 when EPS is set to grow by just 2%. Indeed, shares in the company appear to offer little in the way of value, with them currently trading on a P/E of 21.5 and yielding just 2.4%. While Compass is a high-quality company, shares seem to be pricing in a highly optimistic future that may not be delivered.
