MIDAS SHARE TIPS: Defence role boosts profits at Serco

You don’t have to have a particularly long memory to associate Serco with failure, fines and fraud. 

But despite past infractions, the outsourcing company continues to gain work in recession-proof markets such as immigration, defence, and the Orwellian-sounding ‘Citizen Services’ sector.

The company has come a long way since it was founded to provide services to the cinema industry in 1929, before moving into sound equipment for the British War Office in the Second World War. 

Defender: Serco operates in areas where spending is growing and has a Government contract to maintain UK air defence radar

Now you’ll find it doing a diverse selection of projects including maintaining the UK’s air defence radars, running six prisons, and managing the ferries between Orkney and the Shetland Islands.

Those examples are just the tip of Serco’s considerable iceberg, which also includes controversial areas such as the detention of asylum seekers and, formerly, the Covid Test & Trace system.

Like it or loathe it, the business is seldom out of the news. As just one example, this week the Serco-run Yarl’s Wood asylum centre in Bedfordshire was the subject of a report highlighting an ‘increase in violent incidents’ due to a lack of progress with cases.

But although Serco is not the investment for those who like their holdings to stay well away from the limelight, it compensates by being a defensive stock for difficult times like these. At the end of last month, it provided an upgrade to profit guidance, because so many of its services are in high demand.

Mark Irwin, the group’s chief executive, said governments around the globe are looking to Serco to help with the ‘complex and difficult challenges they face’.

One of the strong performers for the group is newly acquired European immigration services provider ORS. This is helping to make up for the winding down of much of Serco’s Covid work, which provided a boost to revenues during the pandemic.

Analysts raised their profit targets for the company after the update, with RBC’s Andrew Brook saying there is now a ‘high degree of visibility for 2023’ and raising his Earnings Per Share (EPS) forecast for the year by 7.5 per cent.

Peel Hunt’s Christopher Bamberry upped EPS targets by seven per cent, saying the business is ‘well placed to navigate the current macro-economic challenges’.

Though there’s optimism for 2023, that’s not to say that Serco couldn’t surprise on the downside the following year.

Brook, at RBC, notes that some contracts the firm is running are due to drop out in the coming years, and there’s still some uncertainty over the Australian immigration contract Serco holds.

Longer-term shareholders in Serco have had a rough ride. Serco shares were 459p in 2013, before a Serious Fraud Office investigation and fine sent them tumbling. Today, they are 156p, down 12 per cent over the last 12 months. 

That puts them on a relatively undemanding valuation of 11 times earnings in a sector that is rated higher, and with a dividend yield of two per cent to boot. The company also has the benefit of being cash generative, which means the balance sheet is strong.

The company is well-placed to take advantage of expected increases in government spending on immigration and defence in many areas of the world, which would seem to put it at an advantage.

Midas verdict: Serco is not without risk. The loss of Covid-related work means it has had to replace this with other contracts, and making up for the shortfall isn’t always easy.

If the firm loses the Australian immigration contract, due for renewal this year, this could hit profits, while revenue is expected to be lower in Asia Pacific.

The company’s tendency to work in high-profile and controversial areas such as immigration has also led to scandal in the past, something that is extremely bad for share prices.

There’s no suggestion that the current management is likely to lead the company into any problems like this though, since former chief executive Rupert Soames is credited with shaking out any problems at the business, leaving it in stronger shape.

At 156p, the shares are a buy.

This post first appeared on Dailymail.co.uk