Peel Hunt slashes Serco target, reiterates 'sell' due to expensive valuation

Peel Hunt has slashed its target price for Serco by nearly half to take into account a proposed rights issue by the outsourcing group and kept a ‘sell’ rating on the stock.

However, the broker said that the company’s amendment of its financial covenants and a successful conclusion to the prisoner escort and custody services (PECS) investigation are “welcome pieces of news”.

On Thursday, the company reached an agreement with its banks to change its financial convenience, which includes the deferral of the next covenant testing date to May 2015.

“This will ensure that Serco has a solid financial platform from which to implement the refinancing and proposed rights issue planned for the first quarter,” said Peel Hunt Christopher Bamberry.

On Friday, the company announced that police and prosecutors would not be bringing charges against the company in relation to a probe into its PECS contract to move prisoners from custody to courts.

While the developments remove two serious headwinds for Serco, Bamberry reiterated his negative stance to clients, saying that the shares are too expensive.

He said that the stock’s valuation - trading at 22 times estimated earnings for 2016 - “fails to adequately reflect either the likely dilution from the proposed rights issue or the length of time that it will take for Serco to deliver a sensible risk-adjusted margin”.

The broker lowered its target for the shares from 265p to just 135p as it attempts to value the stock on an ex-rights basis.

Serco was down 4% at 159.1p by 10:47.