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?