Serco Group Plc 2018 marked an inflection point

Serco Group Plc (LON:SRP) today announced 2018 full year results.

Rupert Soames, Serco Group Chief Executive, said: “2018 marked an inflection point for Serco. After several years of declining revenues and profits, Underlying Trading Profit at constant currency rose 40%, Reported Operating Profit grew fourfold and Revenue started to grow again in the second half. Underlying Earnings per Share (EPS) grew by 63%, Reported EPS was positive for the first time since 2013, and Free Cash Flow also turned positive for the first time since 2014. Our balance sheet remains strong, with Net Debt : EBITDA for covenant purposes at 1.1x, down from 1.4x in 2017; our pension schemes are well funded; there was no use of working capital finance facilities; we pay our suppliers on average in 30 days and our customers pay us on average in 29 days; and we have recently successfully completed the refinancing of a £250m banking facility committed to December 2023, on terms similar to previous arrangements.

“Strong order intake gave us a book-to-bill ratio of over 100% for the second year in a row, and in addition the acquisition of the Carillion health contracts contributed to our order book growing to £12.0bn at the end of 2018, an increase of around 20% since 2016. Also for the second year in a row, and reflecting the Group’s broad international footprint, 80% of our order intake in 2018 came from outside the UK. Our confidence has been further bolstered by the signing in the first six weeks of 2019 of two very large contracts: AASC – asylum accommodation and support services in the UK valued at £1.9bn, and NGHS – defence healthcare provision in Australia valued at £0.6bn.

“We expect to deliver further progress in 2019, with Revenue and Underlying Trading Profit both expected to grow. Beyond 2019, and consistent with our strategy announced in 2015, we believe we will able to continue to improve our margins, with a target of achieving 5% or above in the longer term. In terms of demand, we now believe that the weighted growth rate across all our geographies and sectors has slowed from the 5-7% seen in 2010-2014 to around 2-3% now; whilst demand in some markets – for example US defence – remains robust, conditions in the UK, which represents about 40% of our revenues, are weak and this is acting as a drag to aggregate market growth. Despite this, our recent strong order intake means that we believe we should be able to outperform a weaker market in the next few years, absent unforeseen headwinds or major rebid losses. We expect Serco to achieve revenue growth of 3-4% in 2019, accelerating to around 5% in 2020 as contracts such as Grafton, Icebreaker, AASC and NGHS become fully operational.”

Highlights

· Revenue(1) at constant currency declined 5.6% in the first half, but grew 2.5% in the second half, resulting in a decline for the full year of 1.7%, comprising a 3.1% organic decline from net contract attrition, partially offset by a 1.4% net contribution from acquisitions. The adverse impact of currency in the full year was £65m, or 2.2%, resulting in a 3.9% decline in revenue at reported currency.

· Underlying Trading Profit(2) at constant currency increased by 40% as a result of a strong operating performance, further good progress on transformation savings and other cost efficiencies, as well as £10m of non‑recurring trading items such as end-of-contract settlements. There was an adverse currency impact of £4.0m or 6%, resulting in a 34% increase at reported currency. Margin increased by a percentage point to 3.3% (2017: 2.3%). The improvement in performance was widely spread, with all regional divisions delivering double-digit percentage growth in UTP and increases in margin.

· Reported Operating Profit increased nearly fourfold, and includes a £23.6m net credit from Contract & Balance Sheet Review items (2017: net charge of £24.2m) offset by a net charge for exceptional items of £31.9m (2017: net charge of £19.6m), neither of which are included in Underlying Trading Profit. Onerous Contract Provisions (OCPs) are ahead of our 2014 plan and the residual liability now stands at £82m, down from £447m in 2014 and £147m at the start of the year.

· Underlying EPS increased by 55%, reflecting the growth in Underlying Trading Profit, together with the benefit of the tax rate reducing from 35% to 26%. Reported EPS, which includes the after-tax impact of non-underlying items as well as net exceptional costs, stood at 5.99p (2017: loss per share of 0.76p).

· After three years of outflows, Free Cash Flow(4) turned positive at £25m.

· Net debt increased by £47m (2017: £32m), as the positive Free Cash Flow was offset by £19m of exceptional items, net acquisition consideration of £31m and a £22m negative net foreign exchange impact largely related to our US$ denominated debt. However, the growth in EBITDA resulted in underlying leverage of 1.23x and of 1.06x for covenant purposes, comfortably around the bottom of our normal target range of 1-2x. During the year we successfully refinanced our banking facility on terms similar to those previously in place, with a £250m Revolving Credit Facility now committed until December 2023.

· Acquisitions: BTP Systems, acquired for £13m in February 2018 with the intention of deepening our satellite and radar capabilities, is now fully integrated within our US defence business. Six Carillion health facilities management contracts in the UK, acquired for £17m, have now been successfully transitioned to our ownership and management.

· Order intake of £2.9bn, book-to-bill ratio over 100%; 80% of order intake was from customers of our Americas, Middle East, AsPac and continental European operations, with the remaining 20% from the UK. 66% of the order intake comprised existing work being rebid or extended, and 34% was new business. The largest award was the rebid of our US health insurance eligibility contract valued at around £700m, with over 40 other awards worth more than £10m.

· Order book increased to £12.0bn, up from £10.7bn a year earlier; the increase includes the strong order intake together with £0.7bn added via the acquisition of the Carillion health facilities management contracts and an adjustment to the definition to align with IFRS15 future contractual revenue.

· Pipeline of larger new bid opportunities increased by £0.9bn to £5.3bn at 31 December 2018; the £2.5bn of contract awards in January and February 2019 for AASC and NGHS have the effect of reducing the pipeline by £1.7bn.

· Revenue guidance for 2019 is increased from a range of £2.8-£2.9bn to a range of £2.9-£3.0bn, reflecting recent contract wins. Following an encouraging start to the year, Underlying Trading Profit is now expected to be approximately £105m under IFRS16; this represents the top end of the £95-100m guidance range given at the Closed Period Update issued on 13 December 2018, together with a £5m increase as a result of the adoption of IFRS16 (with an offsetting £5m increase to Net Finance Costs). Net debt at the end of 2019, excluding lease obligations newly recognised under IFRS16, is expected to be approximately £200m, equivalent to covenant leverage of approximately 1.3x.