FTSE 250 outsourcer Serco Group PLC (LON:SRP) has been upgraded to ‘Buy’ from ‘Hold’ by analysts at City broker Shore Capital following a contract win with the UK government worth £1.9bn on Tuesday.
In a note to clients, the broker said the new contracts, through which the firm will help the government manage more than 5,000 properties occupied by asylum seekers, brought “greater visibility of profit improvement and the return to positive cash generation”.
READ: Serco wins largest ever contract from UK government worth £1.9bn
“In our view, this allows us to consider fundamental valuation criteria for the first time since the group entered its major restructuring programme with the appointment of Rupert Soames as CEO in 2014. We now see, with a reasonable degree of confidence, the emergence of positive cash generation through FY2019F (Dec), with this rising steadily through FY2020F and beyond.”
The broker added that it also foresaw “a return to the dividend list – perhaps in FY2021F when our modelling suggests an FCF yield in excess of 6%”.
“This has been a long road for shareholders and risk is still evident around the company; however, we also see further opportunity in Serco’s global footprint and an opportunity to utilise free cash generation to support growth activities, accelerating normalisation and completing the group’s rehabilitation in investors eyes.”
As a result of the new contracts, ShoreCap altered its forecasts by upgrading its free cash flow (FCF) expectation for the 2020 fiscal year by £10mln to £54mln, adding that across the contract portfolio “the ‘bleeding’ from past onerous contract provisions is now coming to an end, the future is looking more predictable and profitable to our eyes with the balance sheet now beginning to strengthen”.
In its own predictions, Serco said on Tuesday that the Asylum Accommodation and Support Services Contracts (AASCs) would bring in £150mln in revenue in 2020, their first full year, while also being “materially positive” to both profitability and cash flow.
In mid-morning trading Wednesday, Serco shares were up 4.2% at 113.2p.