It’s been a truly disastrous few years for British outsourcing firm Serco Group (LSE: SRP), with numerous contract problems and high-profile scandals that have ultimately strained the company’s relations with the British government, from which it derives half its revenues. Consequently, the FTSE 250 company has been forced to issue numerous profit warnings in recent years, resulting in a share price slump from all-time highs of 553p in 2013, to just 77p earlier this year.
On the road to recovery?
In its interim statement the Hook-based firm said it was on the road to recovery after a strong set of results for the first half of its financial year thanks to cost savings and the fall in the value of sterling. Serco’s share price has been recovering too, gaining 44% since April this year and partly reversing a slide that began three years ago. So is Serco turning a corner and reversing its fortunes, or is this just a dead cat bounce? Unfortunately, I believe it’s the latter.
Firstly, the strong share price rally this year has come from a very low base, and the shares are still worth less than a third of their value of just three years ago. Secondly, broker consensus estimates suggest a rather gloomy outlook. The City is expecting underlying profits to fall by 16% in the current year to the end of December, with profits shrinking by a further 38% next year, by which time the shares will be trading at an astronomical 47 times forecast earnings. I expect gravity and common sense will kick in, and the shares will fall back to earth some time very soon.
Growth, but at a price
In stark contrast to Serco, British-based industrial engineering firm Spirax-Sarco (LSE: SPX) has enjoyed copious amounts of prosperity over the years. The mid-cap firm that specialises in steam management systems and peristaltic pumps has enjoyed rapid expansion and now operates 77 units in 43 countries around the world. Consistent revenue and earnings growth has attracted the attention of investors and has led to a relentless share price climb from under £3 at the start of the millennium to current levels around £46. That’s a 15-bagger!
The Cheltenham-based mid-cap firm recently reported good growth in pre-tax profits for the first half of 2016, and with it announced the acquisition of the assets of Brazilian valve maker Hiter Indústria e Comércio de Controles Termo-Hidráulicos from US-listed Pentair. Spirax expects to benefit from strong cost synergies between Hiter that makes steam and process fluid applications, and its own existing Brazilian unit.
Analysts’ projections suggest Spirax’s revenues will rise to £741m this year, together with a 15% rise in underlying earnings. But after a 57% share price rise over the last 12 months Spirax looks pricey at 28 times forecast earnings. I fear a strong market correction could be on the cards by the end of the year.