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Questor share tip: Serco shows there's still life in UK support services

Blue-chip Serco proved that there is still life in the UK support services sector.

Serco
579½p +25½p
Questor says Buy

The industry has taken a battering over the past year as fears about the scale of Government spending cuts backed up doubts about accounting practices and the failure of companies such as Connaught and Rok.

However, Serco proved that quality operators can still succeed. The company's 2010 results revealed revenue was up 9pc to £4.3bn and pre-tax profits were up 20.8pc. Christopher Hyman, chief executive, admitted there are challenges in the UK, but said the company was still on track to secure revenues of £5bn and an adjusted operating profit margin of 6.3pc by the end of 2012.

Serco is planning to secure growth through overseas markets, while also anticipating a rebound in UK opportunities towards the end of this year as a review of government services leads to the outsourcing of more work in sectors such as defence, prisons and healthcare.

The company runs a vast array of Britain's infrastructure, including the Docklands Light Railway in London, missile early warning systems and the National Physical Laboratory.

However, its overseas operations now account for 40pc of the business, with new contracts including a five-year order to run a monorail system in Dubai and a contract for hazardous-materials handling with the US Navy. The company has identified the US, Australasia and the Middle East as platforms for growth, while the Indian market is also maturing.

Questor first tipped Serco at 455.9p in September 2009 and although the shares are now 27pc higher (compared with the FTSE 100 gaining 23pc over the period) the company has not been immune to the sector's difficulties, hence they were downgraded to a hold.

Serco's shares slid from a high of more than 650p last April to 537p, while its order book has slipped from £17.1bn a year ago to £16.6bn following UK cuts.

However, Wednesday's results reminded the market of Serco's resilience. The company is trading at 15.2 times 2011 earnings and a yield of 1.4pc. This is not strikingly cheap, however Questor believes Serco has set out a stable road map of growth and seen off the worst sentiment. Buy.