Investment Column: Outsourcing mania makes Serco a buy

Informa; Renovo
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The Independent Online

Our view: Buy

Share price: 523.5p (+1p)

Serco's trading statement yesterday was a brief affair, little more than a confirmation that the services group will meet expectations when it publishes its annual results in February.

The expectations are good ones: double-digit revenue growth and a 0.3 percentage point rise in the pre-tax profit margin. The group's share price has also performed well over the last year. The stock followed the market down into its trough in the spring, but has recovered well since, and is now trading more than 20 per cent higher than last December.

On valuation grounds, the stock looks like this is being reflected in the current share price. The price-to-earnings (PE) ratio comes in with a forward multiple of 19.5 times this year's forecast earnings, falling to 16.4 times next year, according to analysts at Panmure Gordon, which is currently at a premium to the sector as a whole. Some City watchers were yesterday downgrading their recommendations, based on the view that the stock's various advantages are already priced in.

But we do not agree. We would argue that all of that is nothing compared with what is to come. Last week's pre-Budget report from the Chancellor of the Exchequer was roundly criticised for the complete absence of detail on where the axe will fall in order to bring the public sector deficit down by half within four years, as is now enshrined in law.

But by offering some semblance of ring-fencing on schools, hospitals and police, Alistair Darling implied cuts of as much as 20 per cent over three years elsewhere, according to the sums done by the Institute of Fiscal Studies.

Serco is usually billed as the company that runs London's Docklands Light Railway, but it does everything from business process outsourcing to defence to education. Outsourcers of Serco's ilk stand to be among the few winners from the slash and burn in the public sector over the next five years. because their services will be in demand if they can show they help to achieve those savings by taking over more of the public sector. So buy.


Our view: Speculative buy

Share price: 296p (+1p)

It seems not all publishers are struggling with the issue of how to overhaul their business model in the digital age. While Informa has endured a "tough 12 months", the business-to-business publishing group is positive over its prospects for the new year.

The group put out a four-line statement yesterday, saying little more than its update in November, but reassuring than it was trading in line with management expectations. Earnings before interest, taxation, depreciation and amortisation should come in somewhere between £305m and £315m.

The company said its publishing business, which brings in 70 per cent of revenues, remained resilient as the subscription model was not affected by the downturn in advertising. There had been fears for its academic division as library budgets are expected to tighten in the new year, but the finance director, Adam Walker, said the company has yet to see any squeeze.

The problems have been more pronounced in the events and training businesses, which are much more cyclical and suffered in the downturn. But the group believes they have hit the bottom, with growth due to return in the new year now cost-cutting is done.

The shares dropped when news of its bid for Springer Science + Business Media leaked and still haven't fully recovered. But Altium Securities rates Informa a good buy at eight times enterprise value to this year's earnings as it represents a discount to the wider sector. With stability next year and growth expected in 2011, we agree. Buy.


Our view: Speculative buy

Share price: 27.5p (-1.5p)

Biotech stocks which have seen potential takeovers collapse and follow by reporting losses before tax of £20.1m usually have big red warning lights flashing above them. But don't rule Renovo out yet. The company has cut its workforce by a third and saved £3m to £4m a year as a result. Cash burn should be no more than £20m annually. With net cash of £65m there should be enough cash to see key drugs through to the all-important stage three trials, with up to £30m left when the first EU phase three trial on Juvista reports in the first half of 2011.

Renovo's drugs are designed to allow healing with less scarring, potentially a huge market. The applications for plastic surgery alone are huge. The company remains open to approaches, but could buy to strengthen, for example, its sales operation. Renovo is a punt, to be sure, but one which could prove rewarding. A speculative buy.