Shore Capital upgrades Serco on £1.9bn government contract

Serco Group’s shares were upgraded from ‘hold’ to ‘buy’ by Shore Capital on Wednesday after the public services outsourcer secured a £1.9bn contract with the UK government.

The asylum services provision contract adds to Shore’s estimated order book for the company of approximately £11.5bn and is expected to generate roughly £150m per year from the third quarter of the current year.

“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,” said a note from Shore Capital analysts.

With the contract taken into account, the broker added marginally to its revenue expectations for the full year, while the full £150m adding 5% to expectations for 2020.

The broker also altered its forecasts following news of the new contracts, upgrading its free cash flow expectation for the 2020 fiscal year by £10m to £54m, 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”.

Furthermore, Shore’s analysts stated that a return to the dividend list in 2021 was possible as their modelling suggested a free-cash-flow 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,” said the note.

Serco Group’s shares were up 5.80% at 114.90p at 1603 GMT.