$SRP.L – Serco – a dividend achiever gone wrong

Business support services company SRP (Serco) released an RNS earlier today, “Update on strategy, capital structure and trading”. The RNS sent the shares down 35% to 206p. The company identified an impairment charge of £1.5bn, reduced “adjusted” operating profit by £20m to £130-140m, reduced its outlook for 2015, mentioned their covenants, proposed a rights issue of up to £550m, and will institute a programme of disposals.

I stopped reading the RNS after that.

What a mess. The lesson for today is this: just because a company raises its dividends 10 years in a row, does not mean that the company has a moat, durable competitive advantage, or that favourable business conditions will continue into the future. How could you have spotted impending disaster? I can’t claim to have many answers, but there is one important tipoff that sticks out at me: the ROCE (on tangible capital) over the last decade averaged 5.9%. I also notice that its average net profit margin over a decade is 3.2%.

I conclude from this that SRP is a terrible business. I have not tried to calculate the company’s cost of capital, but just looking at those numbers, it would have been at best marginal call as to whether any investment in expansion added value. It doesn’t look to me that the directors of the business really knew what they were doing.

SRP is on a PE of around 18, so I don’t see an investment case here.

Over the last six months, this market has been ruthless to weaker companies. As the expression goes, when the tide goes out, you can see who has been swimming naked.

Tesco is another company that, until recently, had been a good dividend performer. Its ROCE has averaged about 5.6% over the last decade. ROCE is by no means a perfect measure, but I can see the merit of Terry Smith’s arguments about ROCE. Neither TSCO not SRP are AIM companies.

Do readers have any other tips for spotting dogs before they bite?


About mcturra2000

Computer programmer living in Scotland.
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3 Responses to $SRP.L – Serco – a dividend achiever gone wrong

  1. Hi Mark, I own small positions of both Tesco and Serco so this has been an interesting few months. Serco’s problem, other than the overcharging of the UK government, appears to be a combination of suicide bidding and investing to make the business larger, rather than to maximise returns to shareholders.

    I agree that ROCE is quite low, so that’s an indicator which I’ve started to incorporate recently (although after the purchase of both Tesco and Serco). But it’s impossible to do an autopsy until the patient is dead (i.e. the investment is sold), and I won’t be selling either company for quite a while yet I would think.

    You never know, both companies may still produce market beating rates of return over the next decade from here, so beware of forecasting disaster when it may not turn out that way (although it might, of course).

    • mcturra2000 says:

      Hi John, thanks for your response. I have a lot of respect for you as an investor, and I hope that your portfolio is doing well. I am very disappointed in the performance of my own portfolio over the last six months, so I am not one to claim any investment skill.

      I think you could be right about Tesco, at least. I know nothing about SRP other than what I skim-read today. Value Perspective published a blog recently about how dividend cutter can go on to outperform, which I am sure you have read.

      The market os staging a nice recovery at the moment, and is only slightly down on the year. It is still being very harsh on companies that disappoint. I get the feeling that the market is still in a cleansing phase. Whether we will have a bear market, I don’t know. I suspect that, at least, we are seeing the start of a rerating which will, in time, present good value opportunities. I don’t think we’re there yet, though.

      All the best, John, and my good wishes to you.

  2. Pingback: Nov 2014 | Mark Carter's blog

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