Additional Information
Market: LSE
Sector: Support Services
EPIC: SRP
Latest Price: 137.60p  (0.51% Ascending)
52-week High: 386.40p
52-week Low: 125.30p
Market Cap: 1,511.58M
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Trader Talk is produced by a team of active traders, analysts and various derivatives professionals from multiple organisations. Trader Talk provides comment on equities, commodities, and other financial instruments based on both technical and fundamental analysis.


 

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Management supports stabilising Serco

May 23 2015, 7:00am

 

A glance at the above chart of the FTSE 100 shows it has been a lacklustre week for equities amid central bank minutes and further weakening of the Euro.

The closely watched minutes from April’s US Federal Reserve meeting highlighted growing doubts amongst policy makers, about the strength of the US recovery after a series of weak data releases. Many officials remain of the view that the slowdown in the first quarter was transitory and a surge in housing starts last month encouraged hopes of improved economic growth this quarter. Housing starts jumped 20.2% last month to the highest level since November 2007, while permits for future home construction jumped 10.1%, the highest since June 2008.

Across the pond, minutes of the May meeting of the Bank of England’s Monetary Policy Committee meeting confirmed that it remained a unanimous vote to keep interest rates unchanged, reinforcing expectations that the first tightening may not occur until early 2016.

A combination of improved US data and expectations for increased European Central Bank bond buying ahead of the summer months, sent the dollar higher. After the US currency ended last week at its lowest level since 22nd January, the dollar rallied strongly, largely benefitting equities in Europe, aside from the miners. 

The single currency took heart from comments that Greece’s labour minister believes Athens would soon conclude a deal with its foreign creditors that could unlock further loans to the country amid a liquidity squeeze. Greece faces payments of circa €1.5 billion to the International Monetary Fund next month, after making its last repayment of about €750 million last week by emptying a holding account at the Fund.

China’s factory activity contracted for the third straight month in May, adding to views that Beijing will have to roll out its most aggressive stimulus measures. The preliminary HSBC/Markit PMI fell to 49.1 in May, weaker than an expected 49.3, marking the fifth contraction in activity in six months. China has already cut interest rates three times in six months and economists believe it will have to ease further to meet the 7% growth target that Premier Li Keqiang this week said he was confident about achieving. 

Domestic data remained robust, as British retail sales rose more strongly than expected in April, recovering from a surprise fall in March, as unusually warm weather encouraged shoppers to buy new clothes. Retail sales volumes rose 1.2% on the month, the strongest increase since November 2014 and ahead of expectations for a 0.4% gain. 

Technical analysis of the FTSE 100 illustrates the rangebound trading, with the index forming a short-term flag formation. Volatility has faded and 7,000 is providing an inflection point that could trigger a sharp move in either direction. The oscillators and rising moving averages indicate the next move will be higher, retesting the recent peak at 7222, although a downward move could send the index back to 6875.  

In conclusion, the FTSE 100 has been consolidating around the psychologically significant 7,000 level, but with the headwinds easing and US indices hitting fresh highs, it appears as though the market has been consolidating before the next move higher. 

Support services have been a beneficiary of the Conservative victory, as Labour wanted to impose limits on the profit outside companies could generate from some government services. A related company I have been following is Serco (LON:SRP), a London-listed international service company. The Hampshire-based company provides end-to-end business process outsourcing (BPO) services to public and private sector customers. The Company operates in Europe, Americas, AMEAA and Global Services. 

Serco has been plagued by a series of disasters and a mismanagement of contracts that have conspired to wipe almost £4 billion off the value of the company and seen the shares fall by more than 75% over the past two years. 

As an investor, the question I find myself asking is: Are Serco shares a falling knife or an interesting investment opportunity?

Rupert Soames, previously of temporary power giant Aggreko, took the helm at Serco in June last year and spent his first nine months conducting a thorough review of the business. The grandson of Sir Winston Churchill, personally phoned the outsourcing group’s head-hunters to put himself forward for the job and has subsequently tempted Angus Cockburn, his finance director from Aggreko to move with him. 

Soames’s review was concluded alongside full year results on 12th March, after revealing a pre-tax loss for 2014 of £1.35 billion, compared to a £108.3 million profit a year earlier, driven by a total of £1.31 billion in one-off provisions against onerous contracts. The dividend was scrapped and the company announced a £555 million, fully underwritten rights issue, in order to cut its gross debt pile by £450 million to about £230 million. 

He summarised his findings by saying: "2014 has been an extremely difficult year for Serco and the magnitude of the provisions, impairments and other charges reflects the scale of the challenges we have had to face. However, there is a real sense that, having confessed our sins and in taking the punishment, we are now ready to start on the path to recovery. We have all we need: a good plan, strong management to execute it and following the successful completion of our proposed rights issue and refinancing, a balance sheet that is an appropriate foundation on which to implement our new strategy."

A list of recent director dealings shows Soames has put his money where his mouth is, purchasing 123,000 shares at 138.239 pence per share (£170,000) and a trading update on 6th May showed the company is trading in line with the expectations outlined at its full-year results in March, indicating no further deterioration in trading. 

Reports this week suggest Serco is close to selling its Indian business processing division to private equity, which may provide a near-term uplift to the shares. The sale is the largest in a number of disposals announced last year as it attempts to restore its ailing balance sheet. It has already sold its Great Southern Rail service in Australia to private equity firm Allegro for £2.5m. Other businesses up for sale include its environmental services arm, which includes Council Street cleaning, and a division managing leisure centres.

 

 

The chart of Serco demonstrates the downward spiral over the past two years, although since March it has been distorted by the effect of the rights issue, so is largely ineffectual.

Serco is now on a more financially stable footing to pursue its strategy of transformation and at 137.8p is below its theoretical ex-rights price of 153.7p. Having put himself forward for the job, I believe Rupert Soames has positioned the company for renewed growth. Near term target are seen at 144.7p, 157.6p and 170p, while traders might consider a stop-loss at 131.7p to minimise risk. 

 

This report was written by Mark Allen – Head of Derivatives at SI Capital Stockbrokers. The writer does not hold a position in Unilever, but client accounts may. The material in this report has come from SI Capital internal data sources, Simply Charts and Unilever’s corporate website.

 

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