Why Carillion plc Is A Better Buy Than Serco Group plc Or Mitie Group PLC

Only one of these three outsourcing companies has beaten the market this year: Carillion (LSE: CLLN), Serco Group (LSE: SRP) and Mitie Group (LSE: MTO).

That company is Carillion, which has gained 4% in 2014, against a wider market fall of 3%, and declines of 12% for Mitie and 65% for Serco!

Boring and predictable

Carillion is undeniably a little dull.

But that’s good, I reckon, given that Carillion’s sensible formula has enabled it to deliver an average annual total return (including dividends) of 8.2% over the last ten years, a full 1% higher than the FTSE 100.

Today’s trading update from Carillion was a case in point: the firm reported new contract wins worth £4.6bn for the year to date, which takes the firm’s order book plus probable orders to more than £18.5bn, £500m than at the end of 2013.

As a result, 85% of Carillion’s revenue for 2015 is secured, which gives a decent level of credibility to the firm’s 2015 forecast P/E of 10.2 and its prospective yield of 5.2%.

Mitie alternative

Mitie isn’t a bad buy: the firm’s shares trade on a 2015 forecast P/E of 11.4 and offer a prospective yield of 4.1%, with forecast dividend and earnings growth of around 5% next year, compared to 1-2% for Carillion.

Higher growth justifies a higher valuation, but given the low profit margins typical in this sector, I’m more attracted to the safety margin offered by Carillion’s much lower levels of gearing — 21% at Carillion, versus 63% at Mitie.

What about Serco?

While we’re on the subject of debt, this year has been pretty disastrous for Serco.

The public-sector focused outsourcing firm has lost 65% of its market value after admitting that it would face significant impairments on a number of big contracts, and would need to issue new shares in order to bring its debt levels under control.

Serco shareholders face the prospect of a £550m rights issue early in 2015, plus a cancelled dividend.

Serco’s new chief executive, Rupert Soames, has an impressive reputation from his time at Aggreko and is probably the right person to turn the firm around. However, I’d question whether Serco is really cheap enough for new buyers to take the plunge: the shares trade on a 2015 forecast P/E of around 16.

For me, Carillion’s combination of modest valuation, 5% yield and growing scale make it the most appealing choice by far.

However, all of these companies have relatively slim profit margins and could be hit hard by future changes in government policy and market conditions.

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Roland Head has no position in any shares mentioned. The Motley Fool UK owns shares in Aggreko. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.