Serco Group PLC

Serco Group PLC (LON: SRP) is an FTSE 250 index listed Company providing public services across defence, justice & immigration, transport, health and citizen services. The Company operates in the UK and internationally.

On 5 August 2021, the Company will release its H1 FY2021 results.

Investment Rationale for Valuation – Speculative Buy at 136.60

• SRP has recently acquired Facilities First Australia (FFA), a leading Australian facilities management company and Whitney, Bradley & Brown Inc (WBB), a leading technology and engineering services provider to the US military. It implies that the Company is aggressively on the growth path.
• The Company has extended its contract with the Royal Air Force with its specialist Surface Finish aircraft painting expertise and won two contracts from the UK Department for Work and Pensions (DWP) with an estimated value of £350 million.
• The management has high confidence in its acquisitions. After the completion of the WBB acquisition, it has updated the FY2021 guidance upwards.
• SRP last paid dividends to shareholders in 2014. However, given solid results and decent guidance, the Board recommends restarting dividends.
• On the profitability front, SRP has achieved a decent performance since FY2019, with net margin always outperforming the industry median of 1.4%.
• The Return on Equity of SRP remained higher than the industry median of 1.0% since FY2019, illustrating higher returns to the shareholders than the industry.

Key Risks

• The Company’s acquisition of WBB and FFA may not achieve the desired synergies, putting revenue and cost pressures on SRP.
• Failure of a business-critical partner or supplier could impact the Company’s operations.
• The Covid-19 pandemic has put service delivery across sectors under tremendous pressure.
• Fluctuations in exchange rates could affect the profitability and financial position of the Company as it has international operations.
• Unfavourable macroeconomic factors could reduce the pipeline of opportunities. 

Recent News

Contract Extension: On 6 May 2021, SRP celebrated its contract extension with the Royal Air Force with its specialist Surface Finish aircraft painting expertise.

Prisoner Property Management: On 30 April 2021, it was reported that SRP introduced an innovative electronic system to manage prisoners' property.

New Contract: On 27 April 2021, SRP announced that it had been awarded two contracts by the UK Department for Work and Pensions (DWP) with an estimated value of £350 million.

Financial Highlights (for the year ended 31 December 2020 (FY2020), as of 25 February 2021)

(Source: LSE Website)

• Driven partly by the Company’s Covid-19 related services and strong demand for immigration services, and helped by the August 2019 acquisition of NSBU; the overall revenue was up 20% YoY to £3.9 billion in FY2020.
• This increase in the top line, coupled with an exceptional gain on disposal, led to reported operating profit surging ~75% YoY and reported diluted EPS by ~153% YoY in FY2020.
• As a result of this impressive bottom line, the free cash flow more than doubled to £135 million, and it helped in reducing adjusted net debt by £157 million to £58 million.
• Given the favourable liquidity position, the Board plans to restart dividend to shareholders with GBX 1.4 per share in FY2020.

One Year Share Price Chart

 (Analysis done by Kalkine Group; Data Source: REFINTIV)

Valuation Methodology: Price/Earnings Approach (NTM) (Illustrative)

Conclusion

Driven by an extensive vaccination programme, the UK economy and the public services sector are coming back on track. The Company has made multiple acquisitions and is expecting favourable results from them. It has even increased its FY2021 guidance given the acquisitions. The Company has also won key contracts recently. SRP has also achieved a significant YoY increase in the year-end qualified pipeline of new business. The stock made a 52-week low and high of GBX 105.90 and GBX 171.65, respectively.

On the technical chart, the next important support level is GBX 125.70.

Based on the increased profitability, liquidity and leverage profile of the Company, its favourable prospect driven by recent acquisitions, improved pipeline of new orders, and support from valuation as done using the above method, we have given a “Speculative Buy” recommendation on Serco Group PLC at the current market price of GBX 136.60 (as on 25 May 2021 at 11.56 AM GMT), with a lower double-digit upside potential based on 16.93x Price/NTM Earnings (approx.) on FY21E earnings per share (approx.).

Batm Advanced Communications Ltd

Batm Advanced Communications Ltd (LON: BVC) is an FTSE All-Share index listed Israel-based Company. It is engaged in the production and marketing of medical and data communication products under Bio-Medical and Networking and Cyber divisions.

Investment Rationale for Valuation – Speculative Buy at GBX 87.10

• BVC has recently started the delivery of two new Covid-19 diagnostic tests to Italy. The tests would be used by Italian public health authorities and the Olympics committee. The new rapid lateral flow test generates results within eight to fifteen minutes.
• To further expand its market, BVC formed a strategic alliance with albis-elcon through BVC’s subsidiary Telco Systems. This alliance would jointly offer BVC’s network function virtualisation solution.
• The Bio-Medical division contributes ~70% of total revenue. Covid-19 brings a tailwind to the Company with continued strong demand for diagnostic test kits and critical care ventilators carrying the sustained momentum into FY2021.
• On the profitability front, BVC’s net margin improved from 1.4% in FY2017 to 6.7% in FY2020, indicating rising performance levels.
• On the liquidity front, the current ratio since FY2016 is consistently above the industry median of 1.65x. On the leverage front, the debt/equity ratio is consistently below the industry median of 0.27x since FY2016.
• In the last two years, the stock has achieved a higher return than its benchmark FTSE All-Share index. Given the prospects of BVC, this outperformance could continue in the future.

Key Risks

• The Company’s strategic alliance with albis-elcon may not achieve the desired results.
• The Company may fail to maintain a competitive advantage in its focus markets.
• If BVC’s research and development programs do not deliver the expected results, the Company could face margin pressures.
• Due to its international operations, foreign exchange fluctuations could impact financial performance.
• Termination of business relationships with key customers and partners could put immense pressure on the top line.

Recent News

Delivery of Covid-19 Tests: On 18 May 2021, BVC started the delivery of two Covid-19 tests to Italy. These two saliva-based RT-PCR test and rapid lateral flow test would be used by the Italian public health authorities and the Olympics committee.

Strategic Partnership: On 12 April 2021, BVC announced that its subsidiary, Telco Systems, had formed a strategic alliance with albis-elcon to jointly offer the BVC’s network function virtualisation solution.

Financial Highlights (for the year ended 31 December 2020 (FY2020), as of 22 February 2021)

(Source: LSE Website)

• Driven by the demand for Covid-19 diagnostic kits and critical care ventilators, the revenue in the Bio-Medical division surged by ~100% YoY to USD 128.7 million in FY2020.
• However, the pandemic affected the Networking and Cyber division revenue negatively. Due to reduced ability to travel to customers' premises and install equipment, the top line in the Networking and Cyber division was down ~6.9% YoY to USD 54.9 million in FY2020.
• Bio-Medical division contributes to ~70% of total revenue. Hence, a ~100% surge in its revenue led to a YoY total revenue increase of ~49%.
• The significant rise in revenue resulted in ~100% surge in EBITDA and ~139% increase in EPS despite ~62% rise in operating expenses reflecting ~51.5% increase in research and development expenses.
• Driven by the dramatic surge in the bottom line, BVC’s cash position rose ~24.6% YoY in FY2020.

One Year Share Price Chart

 (Analysis done by Kalkine Group; Data Source: REFINTIV)

Valuation Methodology: Price/Earnings Approach (NTM) (Illustrative)

Conclusion

The rising aged population of the UK would support a massive demand for medical products. Also, the UK government focuses on science and research, which fuels further growth for the biomedical industry. Driven by Covid-19 tailwinds, there would be continued robust demand for BVC’s Covid-19 diagnostic kits in FY2021. BVC also has new strategic partnerships which could help it to expand its market. The management expects a higher gross margin in FY2021. The stock made a 52-week low and high of GBX 78.40 and GBX 150.50, respectively.

On the technical chart, the next important support level is GBX 78.40.

Based on better liquidity and leverage profile of the Company than the industry, its decent prospect driven by Covid-19 tailwind and strategic partnerships, expected improved gross margin, and support from valuation as done using the above method, we have given a “Speculative Buy” recommendation on Batm Advanced Communications Ltd at the current market price of GBX 87.10 (as on 25 May 2021 at 2.20 PM GMT), with a lower double-digit upside potential based on 52.52x Price/NTM Earnings (approx.) on FY21E earnings per share (approx.).

*Depending upon the risk tolerance, investors may consider unwinding their positions in a respective stock once the estimated target price is reached or if the price closes below the support level (indicative stop-loss price).

* The reference data in this report has been partly sourced from REFINITIV.

*Dividend Yield may vary as per the stock price movement.

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