Serco rallies, but mountain to climb

Serco has been a spectacularly poor performer over the past two years. In that time, a series of profits warnings, scandals and a huge cash call has wiped out over 80% of the company's valuation. Shareholders have been watching closely for any glimmer of hope, and this trading update ahead of next month's first-half results "seems reasonably positive," according to one broker.

"Trading in the year to date has been a little better than we anticipated," said Serco Wednesday. Boss Rupert Soames said the firm was "in reasonably good order", but admitted that the recovery is at an early stage and that there "will be bumps along the road". That was enough for the shares to spike by as much as 15% in early trade.

Still, expectations for the full-year remain unchanged from those set out in March. That means 12-month revenue of £3.5 billion, trading profit around £90 million and cash profit of £160 million.

For the six months, look for revenue of "not less" than £1.7 billion. That's down from £2 billion a year ago, driven largely by reduced volumes and rates in Australian Immigration Services and end of contracts like Docklands Light Railway and US intelligence agency IT support services. Trading profit should remain flat at £45 million, excluding provisions.

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Around £1 billion of contracts were signed over the six months, although it was quiet, with few major bidding outcomes due. Selling its offshore private sector Business Process Outsourcing (BPO) business - mainly the India-based Intelenet operations - is proving tricky, too, and chiefs are considering a number of "alternative options". At least the run-rate of losses on mainly UK onshore BPO work will be "significantly" lower next than in 2015.

Net debt, meanwhile, has halved to about £350 million, although free cash outflow of £150 million over the period - expected to be first-half-weighted - offset some of the £500 million contribution from the rights issue.

And despite recognising some progress on its turnaround has been made, JP Morgan repeats its 'neutral' rating given the highly uncertain outlook for contract wins and retentions. But a big increase in its assumption for Serco's tax rate means its earnings per share (EPS) forecast for 2015 drops to 3.1p and to 3.5p next year. It's why the broker has cut its price target from 188p to 164p.

Even baking in recovery expectations, Serco shares, at 132p, trade on over 42 times JP Morgan's current year EPS estimates. That drops to an only slightly less eyewatering 38 times for 2016.

We'll hear more at results time on 11 August.

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