Thetrading updatereleased today by Serco (LSE: SRP) did little to convince me that its stockis a fair buy at this price, in spite of a 14% surge in early trade.In fact, Id rather choose G4S(LSE: GFS) orCapita (LSE: CPI) if I were to invest in the outsourcing sector.Heres why.
Iwarnedin June 2014about the perils of investing in Serco, and ever since the stock has lost 60% of value. It currently trades at 130p but I am not interested, although opportunistic trades may find a compelling argument to buy into it a change of ownership, for instance.
Management said that trading in the year to date has been a little better than it anticipated, confirming guidance for the year, according to whichrevenues will likely to be around 3.5bn, trading profit will hit 90m, while earnings before interests, taxes, depreciation and amortisation is expected to come in at about 160m these figures are consistent with half-year revenues of not less than 1.7bn, and trading profit of not less than 45m.
As its restructuring continues, Serco also noted that itsindebtedness is going down, and taking account of other non-trading movements, including cash exceptional costs as previously indicated, net debt at 30 June 2015 is anticipated to be approximately 350m (31 December 2014: 682m).
A rights issue has helped it fix its balance sheet, but free cash outflow for the 2015 financial year as a whole is expected to be approximately 150m.
I need to see a positive free cash flow yield before suggesting that the business is sustainable.
G4S & Capita
G4S is a more valid alternative, although its financial are not completely reassuring and I doubt that capital appreciation will be meaningful over time.
Its stock is up 4.7% over the the last 12 months, while trading multiples based on earnings, cash flow and book value suggest that its stock is fully priced right now. Moreover, a high forward dividend in the region of 3.6% signals risk rather than opportunity, and I am not comfortable withits net leverage position based on its cash flow profile.
Its certainly a safer bet than Serco, butit may not be worth the pain, Id argue and there are better options, such as Capita, whose stock has risen 7% over the last 12 months and 14% since the turn of the year.
Its operating and net margin double those of G4S and are also much higher than Sercos, which is one element I like, while its net leverage is more manageable, and that is reflected in a lower dividend yield, which stands at 2.6% on a forward basis.
Trading multiples do not point to a bargain trade, though, and thats one of the reasons why Id probably look elsewhere for value.
For instance, I’d certainly consider a transport company mentioned by ourMotley Fool analysts in this free investmentreport.Its balance sheet is solid, andits stock price has risen 15% in the second quarter—but forward p/e multiples in the region of 14x/12x suggest that upside could be much higher into 2016 and beyond. Furthermore, if you are after a solid yield play, consider that itsforward dividend yield is almost 3% and is properly financed and covered.
I flagged this stock some time ago; it has now drawn the attention of analysts at Barclays, HSBC and UBS, who raised their price targets by10% in recent days.So, download our free report right nowand find out more about your next trade!