Every couple of years, the market takes a look at outsourcing companies, decides that the years of consistent growth in earnings and dividends just cannot continue, and concludes that their hefty price/earnings ratios are no longer justified. Sometimes, there is a topical reason for this – such as the government’s Comprehensive Spending Review (CSR) – and sometimes not.
Even so, I have held the outsourcers Serco and Capita in my portfolio for the best part of a decade, and remain pretty pleased with them.
A single pound invested in Capita in 1990 with dividends reinvested would have been worth £204 by the end of October – which is the best performance of any stock now in the FTSE 100, according to the
FT magazine Investors Chronicle. For Serco, whose dividends are a tad lower, one pound in 1990 would be worth £70, putting it in fifth place in the FTSE 100. Only Sage, Antofagasta and Tullow Oil have done better.
Having said that, Serco made an uncharacteristic blunder in October with its demand that top suppliers make rebates to soften the blow of government savings. Once a letter was leaked containing finance director Andrew Jenner’s menacing phrase “. . . we are looking to determine who our real partners are . . . ”, it wasn’t long before Cabinet Office minister Francis Maude expressed his anger – and the company’s shares fell
8 per cent.
Serco, which had prided itself on its collegiate approach with staff and customers, had made itself sound like Tesco.
This is a classic case of reputational damage – one I identified in this column in April. Outsourcing companies need to cultivate their main customer, the government, very carefully, given public fears that outsourcing companies make profits by cutting service quality.
Putting this right is going to take time, even though the business models of both companies have not been dented by the CSR. Indeed, the long-term opportunities are greater now than before.
What is true of outsourcing companies is equally true of funeral directors. Though few bereaved relatives will quibble over the cost of a funeral, they certainly will complain if the service is not excellent, dignified and respectful.
However, given the reliable nature of the business model, I am surprised that funeral company Dignity doesn’t have any listed rivals. It has a 12 per cent share of the market, and annual growth is just north of five per cent in both revenues and profits – augmented by a steady stream of acquisitions from private funeral directors as they retire. The company has also begun adding “satellite” operations near existing facilities.
In the longer term, this could pep up the growth rate. The dividend yield is a little disappointing at just over 2 per cent, there is substantial long-term debt, and the p/e is quite full at 13, but there are other attractions.
I bought the shares this October at 683p ahead of a cash distribution and six for seven share consolidation worth £1 per share. While there are now bond costs to fund, earnings have been enhanced by being spread over fewer shares. As a strongly defensive stock, the shares haven’t done much since then, and will probably mark time for a few months until the capital restructuring is digested. Even so, I reckon they are well placed for the longer term.
Nick Louth is an active private investor, writing about his own investments. He may have a financial interest in any of companies, securities and trading strategies mentioned.