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

Shot of a young Black woman doing some paperwork in a modern office
Investing Articles

With an 8% dividend yield, I think this undervalued FTSE stock is a no-brainer buy

With an impressive yield and good track record of payments, Mark David Hartley is considering adding this promising FTSE share…

Read more »

Passive income text with pin graph chart on business table
Investing Articles

£9,500 in savings? Here’s how I’d try to turn that into £1,809 a month of passive income

Investing a relatively small amount into high-yielding stocks and reinvesting the dividends paid can generate significant passive income over time.

Read more »

Businesswoman analyses profitability of working company with digital virtual screen
Investing Articles

Dividend star Legal & General’s share price is still marked down, so should I buy more?

Legal & General’s share price looks very undervalued against its peers. But it pays an 8%+ dividend yield, and has…

Read more »

Investing Articles

Dividend shares: 1 FTSE 100 stock to consider buying for chunky shareholder income

This company’s ‘clean’ dividend record looks attractive to me and I’d consider buying some of the shares to hold long…

Read more »

Investing Articles

3 of my top FTSE 250 stocks to consider buying before April

Buying undervalued UK shares can be a great way to generate long-term wealth. Here, Royston Wild reveals a handful on…

Read more »

Ice cube tray filled with ice cubes and three loose ice cubes against dark wood.
Investing Articles

Just released: our 3 top income-focused stocks to buy before April [PREMIUM PICKS]

Our goal here is to highlight some of our past recommendations that we think are of particular interest today, due…

Read more »

Investing Articles

Is this the best chance to buy cheap FTSE 100 shares in a generation?

I want to buy shares when they're cheap, and sell... never, just keep taking the dividends. And the FTSE 100…

Read more »

Man putting his card into an ATM machine while his son sits in a stroller beside him.
Investing Articles

Could NatWest shares be 2024’s number one buy for passive income?

For those of us looking to earn some long-term passive income, how does NatWest's 7% dividend yield sound? It sounds…

Read more »