It's too soon to get back into Serco, Nomura says

It was too soon to jump back into shares of Serco, analysts at Nomura believed.

The provider of services outsourcing for national and local governments was still facing a difficult outlook, the broker said.

Serco's management believed it would be able to lower the company's net debt to about twice earnings before interest, taxes, depreciation and amortisation by year-end.

That was about right, but analyst Andrew Chu cautioned that net debt would only peak at approximately 2.8 times operating profits at the end of 2018.

Furthermore, Chu estimated the company would not generate any positive free cash flow over the next three years.

Onerous contract provisions would weigh on the Hampshire-based firm’s cash flow to the tune of £90m in 2016 and by a further £60m in 2016 and 2018 each.

Compounding matters, there was a lack of clarity around its growth prospects over that same time horizon.

Indeed, for 2018 Chu was forecasting a trading profit of £58.1m, 33.0% less than the Bloomberg-compiled consensus.

Nevertheless, Nomura continued to apply a 20% premium to its estimate for the company’s EBITDA in 2017, due to the depressed levels of that metric.

On a multiple of 13.2 times enterprise value to EBITDA that yielded a target price of 96.0p, Chu said in a research note sent to clients.

He reiterated his ‘neutral’ recommendation on the shares.