Thursday, 30 January 2014

Serco - reading both parts of the update statement

The UK-listed outsourcing company Serco is still in a volatile period of its corporate life.  The last six months has seen a number of senior management changes, following criticism by UK government officials about the nature and style of some of their contract management. 

I have been building a position slowly using volatility to aid timing.  Well, there was another chance today with an update from the company which helped push the shares back towards the 420p level from which they bounced last November. 

So what did they say?  The volatility-inducing part of the statement came in the outlook for 2014 section which highlighted that:

'A mid-single digit percentage organic decline on 2013 revenue is now anticipated.  This reflects the lower level of incremental work won across the Group to date, the attrition from contracts lost such as Electronic Monitoring, and our latest assessment of the impact of volume reductions in our Australian immigration detention services contract to which we referred in November'. 
Unsurprisingly all the bad press and government agitating has had some impact on sales and bids.  This is no huge surprise but via lower margins and one-off costs it has had an impact on the anticipated market consensus numbers:

'Market consensus for 2014 Adjusted operating profit is currently £277m.  Given the factors identified above, we currently anticipate a result that could be 10-20% lower than this for ongoing activities, on a constant currency basis'
It feels to me as if the market consensus is a bit behind-the-curve.  Back in September, when Serco left the FTSE100, I noted that the company was likely to make £300m of operating profit in 2013 despite all the bad publicity and issues. The share price back then was 550p.  Today, using the updated 2014 guidance, the mid-point decline in year-on-year operating profitability is just over 21%.  And what share price would this suggest?  431p. 
The share fell to just below this level on the announcement but I observe the market - in classic fashion - is not paying attention to the first part of the statement released today.  Serco has been forgiven by central government due to the changes it has made to personnel and style/structure.  This does cost money and it has knocked them out of a few contracts whilst the changes were being made, but the 2015-16 hopes for the company are now not factored in at all.  Governments around the world still need to outsource materially to help save money and improve deficit positions.  Reformed Serco is still in a good position to aid here. 
A share price in the 420s again would be an opportunity to add akin to the volatility seen in November. 

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