The good, the bad and the uncertain
Serco Group's, (SRP) update relating to the corporate renewal plan contained positives in the cabinet office approval, but also plenty of negatives. With the updated 2014 outlook signalling a 10-20% downgrade to consensus EBITA and continued uncertainty around the level of sustained impact during a year of higher-than-average rebids, we are unsurprised by the 17% fall in the shares. The combination of the current uncertainty and the fact that a new CEO will not be in place until the summer at the earliest, suggests that the current discount to peers is likely to persist in the short term, although the group should emerge in a stronger position over the longer term.
The good: Renewal programme approved
The announcement that the cabinet office had audited and approved the group’s corporate renewal programme provided the positive from the statement. This enables the group to be awarded contracts once again, on an equal footing with competitors. While the group had not been excluded from bidding, the fact that UK government contracts were not allowed to be concluded has provided a drag on pipeline conversion. The announcement paves the way for forthcoming decisions on the Defence Infrastructure Organisation (DIO) and Northern Rail rebids.
The bad: Deterioration of forecasts since IMS
The disruption caused by the corporate renewal programme, as well as a deterioration in the group’s largest contract, caused the group to announce that it expects 2014 EBITA to be some 10-20% below consensus of £277m. The main causes for this were: incremental ongoing corporate renewal costs, £10m; one-off costs for advisors, £15m; a net impact of portfolio adjustments since November’s IMS (UK Transport/Clinical Health), £7m; currency, £2-3m; and lower anticipated revenue on the higher-than-average margin contract (£400m pa Australian Immigration), now forecast to decline between 25-50% cf up to 25%.
Valuation: The uncertain – can it get worse?
The 17% drop in share price was unsurprising, given further uncertainty remains. The rating is c 13x CY14 implied EPS, a 16% discount to peers Babcock (18.2x), Capita (15.6x) and G4S (13.4x). With a new CEO not expected to be in place until the summer at the earliest, we anticipate that such a discount is likely to persist in the short term, although in our view the longer-term market opportunity remains and the group is likely to emerge in a stronger position, but this will take some time.
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