Serco making progress in 'less than ideal' trading conditions

Outsourcing giant Serco Group updated the market on its trading on Friday, ahead of its first half results due in early August, saying that for the first six months of the year it expected to report revenue of around £1.35bn, and underlying trading profit of between £35 and £40m.

The FTSE 250 firm said that, for the comparable period last year - restated for IFRS15 - revenue was £1.51bn and underlying trading profit was £34.0m.

It said the results for the first half of 2018 included adverse currency impacts of around £60m for revenue and between £3 and £4m for underling trading profit.

Therefore, at constant currency, revenue was anticipated to have reduced by around 6%, and underlying trading profit to have improved by around 20%.

Serco said that, as it expected, the revenue reduction was driven largely by contracts that ended in 2017, while the profit increase was driven by transformation savings.

Its guidance for the full year was for revenue of between £2.7bn and £2.8bn, and underlying trading profit of around £80m, compared to the IFRS15-restated result for 2017 of £2.95bn revenue and £69.3m underlying trading profit.

“We therefore do not anticipate any material change to analyst consensus for underlying trading profit for 2018, although, as we have previously stated, there remains a wide range of potential outcomes reflecting the sensitivity of our profits to even small changes in revenues and costs, as well as further movements in currency during the second half of the financial year,” the Serco board said in its statement.

The company said its order intake had continued to be “strong”, driven in particular by progress on securing rebids and extensions.

Including the anticipated value of option periods for the company’s health insurance eligibility contract and its naval electronic surveillance systems contract, both in the US, along with the value of other awards across its UK and Europe, Middle East and Asia-Pacific divisions, the firm said it expected more than £1.5bn of order intake in the first half, and therefore its book-to-bill ratio continuing to run at over 100%.

The company also update shareholders on its planned acquisition of a portfolio of selected UK health facilities management contracts from certain subsidiaries of the now-defunct Carillion.

Serco said it had been working “closely” with the special managers and liquidators of Carillion, together with other relevant parties, to agree acquisition terms enabling the various contracts to transfer.

“We are now anticipating that we will take responsibility for facilities management services at six major NHS hospital sites - Great Western Hospital in Swindon; Darent Valley Hospital in Dartford; James Cook University Hospital in Middlesbrough; Harplands Hospital in Stoke-on-Trent; the Langlands Unit of Queen Elizabeth University Hospital in Glasgow; and Addenbrooke's Treatment Centre in Cambridge,” the board confirmed.

It said the first contract - Great Western Hospital in Swindon - transferred recently, with the remainder, subject to signing of the relevant contracts, expected to do so over the coming weeks.

Each of the remaining five contracts still required a separate transaction and novation, with Serco reporting that if all six contracts transferred to it, the total annual revenue would be around £70m with the estimated underlying trading profit, including an appropriate allocation of charges for shared support services and other incremental overheads, of about £4m.

Together, all six contracts would add around £700m to Serco’s order book.

Reflecting the reduced number of contracts transferring and other changes to the transactions, the aggregate consideration payable, assuming all of the relevant contracts are transacted and novated, would be about £16m, the board said.

“As there would only be a part-year trading contribution in 2018, after the costs of the transition and integration phase that would be completed over the coming months, this would likely result in a small negative impact on Serco's net profitability for the 2018 financial year,” the board explained.

“This has been taken into account in our guidance as stated in today's update on trading.”

Serco said the transactions would be “immediately accretive” to earnings following the completion of the integration phase.

The company’s previously stated estimate of accounting net debt at the end of 2018 was a range of between £200m and £250m, equivalent to leverage for covenant purposes of 1.5-2x EBITDA.

It said the guidance it provided in February excluded the potential effect of the proposed acquisition of Carillion healthcare contracts.

Assuming the transaction progressed as currently anticipated, the firm said it would not expect it to have a material impact on its net debt in the first half, but would leave it at the upper end of the range at the close of the 2018 financial year.

A final update would be provided when all potential transfers were completed, Serco’s board added.

“As foreseen in our five-year strategy, profits are now starting to grow and we expect underlying trading profit to increase by around 20% at constant currency in the first half,” said Serco Group chief executive Rupert Soames.

“The period has also seen a continuation of the strong order intake we saw in 2017, with contract awards expected to exceed £1.5bn, representing over 100% book-to-bill ratio; consequently we expect to show continued growth in our order book.”

Soames said around 80% of the company’s order intake would have come from its operations outside the UK.

“In addition, we have progressed with value-enhancing acquisitions, completing and integrating the BTP acquisition within our US defence business to deepen our satellite and radar capabilities, and we have now transferred the first of the Carillion healthcare contracts.

“Notwithstanding market conditions that are less than ideal, particularly in the UK, we are responding appropriately and continuing to make progress in line with our strategy.”