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Questor share tip: Serco’s lower debt means less investor risk, and analysts are pencilling in the return of a dividend
It is fair to say that this column was either too late in analysing the potential for a turnaround at support services giant Serco or too early. Either way, the result is a paper loss but last month’s trading update reads well enough to support a case for patiently holding on to the shares. The statement was admittedly a little light on detail but the company did boldly state that 2018’s results will come in "meaningfully" above market forecasts.
The good news came in three forms.
First, sales are expected to be £2.8bn, against prior guidance of £2.7bn to £2.8bn. Second, underlying trading profit is seen reaching £90m to £95m, against a prior forecast of £80m. Finally, net debt is seen coming in at the lower, rather than the upper, end of the previously forecast range of £200m to £250m.
The lower debt is particularly encouraging, as lower debt means less risk and less risk means that investors may start to feel more comfortable paying a high multiple of profits to access the company’s earnings stream.
There is still a long way to go here, and Serco remains guarded about 2019’s prospects, which it will discuss more fully alongside its next trading update on Dec 13. But some analysts are pencilling in a 1.1p dividend for 2019 and if Serco does return to the dividend list after an absence that dates back to 2015 that would indeed be a positive sign.
Questor says:This complex company has many moving parts and there is still much to be done, but the reduction in debt means there is no need to give up on the turnaround and crystallise any paper losses.
Ticker: SRP
Closing price: 98.20p
Update: Tesco 5.5pc 2033 bonds
A decision by credit rating agency Fitch to upgrade Tesco’s debt from BB+ to BBB- might not sound important. But it is. That shift takes Tesco from "junk" status back into the realms of investment grade. This is a major step forward in the company’s wider financial rehabilitation under chief executive Dave Lewis (even as the accounting scandal court case begins again in London).
It is also good news for holders of the Tesco 5.5pc 2033 bonds as it gives additional comfort that the retail giant is capable of delivering the £5.50 in welcome annual coupon payments until the debt matures in 14 years and three months’ time. At the current price, the running yield is 4.7pc, while the yield to maturity (which adjusts for how the bonds will be redeemed at par of £100 and thus factors in the book loss relative to the current £116 price) is around 4.0pc.
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That still handily beats inflation and represents a respectable pick-up relative to the UK 10-year Government Gilt, where the yield is 1.72pc at the time of writing.
Questor says: The bond’s attractions as a core income holding are enhanced by the rating upgrade (unless you think inflation is suddenly poised to break out).
Ticker: 31CM
Closing price: 216.00p
Update: Avesoro Resources
This column’s plan to find some portfolio protection with West African gold miner Avesoro Resources (May 29) is so far coming unstuck on two counts, but markets are wobbling a little and having some form of insurance is always a fair plan.
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The first is the gold price is still mired below $1,200. As discussed back in spring, rising interest rates and bond yields are unlikely to help as gold offers no yield itself. It may take a panic by central banks, and a policy flip-flop to cutting rates and increasing quantitative easing, or a sudden spike in inflation to fire the precious metal higher.
The second is Avesoro’s production woes at the Youga gold mine in Burkina Faso, which meant that total third-quarter production at the firm fell 20pc to 47,700 ounces. Improved performance at Youga in Q4 would reassure although a strong first half means Avesoro is sticking to its original full-year output targets.
Questor says:Avesoro could still provide useful portfolio protection.
Ticker: ASO: AIM
Closing price: 185.50p
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