Serco is worth a look from investors

Apr 14 2008 by Peter McCusker, The Journal

STOCK markets have been volatile over the last 12 months and against the backdrop of a slowdown in the growth of the global economy and the spectre of the US economy slipping into recession, many investors are reaching for their tin helmets.

Also, factoring in a potential crisis in the banking sector arising from sub-prime mortgage lending in the US and the ensuing “credit crunch”, which accelerated the demise of Northern Rock, investment risk has moved sharply into focus for shareholders.

In such challenging circumstances, investors looking to mitigate risk may wish to concentrate on factors such as profitability, the visibility of a company’s earnings stream and its record on delivering earnings growth. This often highlights utility companies, but for investors seeking alternative candidates, the support services sector contains several companies that might interest investors.

Serco Group is a support services group that manages contracts for clients such as governments and local authorities. It has four main divisions, Civil Government, Defence, Transport and Science, through which it provides a diverse range of services such as prison management, safety advice relating to nuclear submarines and technical support to particle physics laboratories.

The high quality of Serco’s client base and the long-term nature of the contracts that they operate offers potential investors a relatively high level of visibility of the company’s earnings. Indeed, the public sector accounts for 70% of the group’s revenues and 25% of revenues are generated through its international businesses. Currently 91% of earnings for 2008 is already on the order book, with 76% secured for 2009. Also, a fair gauge of Serco’s operational success is its 93% contract retention rate.

The company is also adding new contracts to its established operations and in February won a £265m 10-year contract to provide information and communication technology services to the Glasgow City Council Joint Venture partnership.

Serco is bidding for contracts worth £27bn, the largest of which is the Sellafield Nuclear Site decommissioning contract. Management conservatively estimates that, if successful, the five-year contract would generate £2bn and add at least 10% to earnings but there is also the option to extend the contract for a further 12 years.

Serco is a well managed business with the potential to deliver significant earnings growth and the clarity of its earnings stream may prove attractive to some investors.

However, investors’ individual circumstances should always be considered, as no investment is suitable for all circumstances, and appropriate advice should be sought before undertaking any investments.

Fergus Westwood, Assistant director and investment manger, Brewin-Dolphin.