Serco Group (LSE: SRP) shareholders have had a tough time, with their shares down 80% over five years, after profit warnings and a weak set of results for 2016. And 2017 results are expected to bring in a big drop in EPS too, though the signs of a successful turnaround look like they’re starting to show through.
Full-year results are due on 22 February, and according to December’s update they should be better than previously expected. Profit should be towards the top end of guidance, with net debt towards the lower end. The firm expects to report an order intake of more than £3bn, and the key thing for me is that “strong profit growth” is on the cards for 2018 and 2019.
The move back to growth got an extra boost Wednesday, as the firm updated us on its planned acquisition of a portfolio of health facilities management contracts from failed Carillion.
The deal has been revised, and should all of the planned contracts be transferred to Serco, the total payable would amount to £29.7m. That’s cheaper than the £47.7m initially envisaged in December, and covers “substantially all of the assets” originally targeted.
The lower consideration is due to “Serco’s re-evaluation of potential liabilities, indemnities, warranties and the additional working capital investment required as a result of Carillion’s liquidation.” But expected revenues are unchanged — estimated at around £90m annually.
The mooted 2017 earnings fall puts the shares on a P/E of over 30 at today’s price of 84p, but two years of forecast growth would drop that to under 19 by 2019. That’s still a bit heady, but I can see the start of a solid recovery — and a decent long-term buy.
AA (LSE: AA) shares have lost over 70% of their value since a peak of more than 430p in March 2015. We’re looking at just 115p today, giving us a very low P/E of just 5.5 based on expectations for the year ended January 2017 — and that would drop as low as 4.8 on 2019 forecasts.
Earnings are expected to turn upwards this year, and there are well-covered dividends yielding better than 5% on the cards. And last week’s pre-close update looked promising.
The big problem for AA is the debt that it has been saddled with since flotation in 2014. The company did refinance some of it in July 2017, but at the halfway stage it stood at almost £2.7bn.
That was slightly down on the £2.8bn level a year previously, but I don’t see any signs of a serious reduction. To put it into perspective, the market capitalisation of the company stands at just £700m — and debt of £2.7bn is almost eight times the company’s expected EBITDA for the current year.
That’s massive debt by any standards, and the big question is whether it’s sustainable without turning to a new equity issue to raise more cash. I have my doubts, and I really do think some sort of cash injection will be needed.
Despite these problems, Neil Woodford holds AA as an income stock. And though there is clearly risk here, I don’t see a great danger to the thrice-covered dividend (the cost of which is tiny compared to the debt, so suspending it wouldn’t help).
At super-low P/E levels, I see too much fear built into the price, and I’d be tempted.
One way to offset the risk of companies like Serco and AA is to pair them with investments in stocks that look safer at less volatile price levels, especially ones in different sectors
The company selected in our Top Growth Share From The Motley Fool report has already provided handsome rewards, our analysts think it has a lot more to give, and it looks a safe pick to me.
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Alan Oscroft has no position in any of the 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.