G4S's Olympics Punishment Could Be A Buying Opportunity

Published in Investing on 13 November 2012

The shares are cheap if the bad news is behind it.

We might not know whether the Olympics legacy has been economically beneficial for the country, but there is one company that is definitely suffering from its disastrous Olympics performance. That, of course, is outsourcer G4S (LSE: GFS), which infamously failed to provide enough security guards, forcing the government to call in the troops to cover the shortfall.

What many feared would be a persistent legacy for the company has come to pass. Last week the Ministry of Justice stripped G4S of its contract to run Wolds Prison, the first prison to be privatised in the UK. And it has been excluded from a short list of contractors to run four more prisons that includes rival Serco (LSE: SRP).

But that's scant consolation for Serco as the government cancelled the privatisation of three prisons and announced a scaling-back of the programme. As predicted, G4S's Olympics debacle has tainted the UK public sector outsourcing industry and got government ministers running scared.

Impact

How bad is this for G4S investors?

It has some impact on future earnings. The Wolds Prison contract was worth only around £9 million a year but the company's exclusion from government short lists is a wider concern and it will, of course, suffer along with the rest of the sector from a rowing back of public sector outsourcing. That's on top of the £50 million the company provided for the Olympics contract.

And the reputational damage is significant. Somewhat unfortunately, G4S's CEO Nick Buckles had said only earlier in the week that the prison outsourcing announcements would be the real test of the post-Olympics climate for the company. Though the director in charge of the Olympics business has just resigned, Mr Buckles himself has held on to his job in the face of high-profile criticism.

One reason for that is support received from investors. Under his direction, the company has grown to be the world's largest security firm. One of his most vocal supporters is Neil Woodford, who, as manager of Invesco Perpetual's high income fund, is G4S's second-largest shareholder.

Positive

It's not all bad news. The prison announcement overshadowed a positive third-quarter trading statement. Organic revenue growth -- excluding the Olympics -- grew 5.5%, combining a 9% growth in developing markets and 4% in developed markets.

That developing markets figure is important. Not only is it growing faster, but margins are much higher. At the half-year, developing markets contributed 30% of turnover but 40% of cash profits. The diversity of G4S's business, by market and by geography, gives it resilience and growth potential.

Cheap

After falling back on the latest news, the shares are cheap. A 3% fall has taken them to not far above the bottom they hit after the Olympic story broke. In fact, you can now pick up G4S's shares at the same price they were trading at the end of October 2009, while markets were still in shell-shock from the financial crisis. The FTSE 100 (UKX) has risen nearly 10% in that time.

G4S's shares are on a prospective P/E, based on analysts' estimates of 2013 earnings, of just over 11. That's well below its historic trading range, and much cheaper than sector peers Serco on 13.5 and Capita (LSE: CPI) on 14. That might be justified if G4S's recent contract loss is the start of a trend, but shareholders will be hoping that after some visible blood-letting, ministers will now judge G4S on its merits.

They can ill afford to lose one of the few bidders capable of taking on major public sector contracts. Despite the recent tilt away from outsourcing, it's still a massive business.

Sector

That's one reason why G4S's number two shareholder, Neil Woodford, is so positive on the sector that he holds all three companies, G4S, Serco and Capita, in his index-beating portfolio. He avoided techs in the dotcom bubble and banks in the credit boom, so he knows something about sectors to steer clear of as well as those to invest in. You can find out more about where the UK's leading stock-picker is investing in this Motley Fool report: "8 Shares Held by Britain's Super Investor". It's free and you can download it here, without any obligation.

Ironically, Capita could be the biggest loser if UK ministers lose their nerve over outsourcing. It has just issued a confident trading statement, but is relatively more dependent on UK public sector contracts. Serco, which is relatively skewed to UK and Europe but has a broader business mix, might be the beneficiary if G4S continues to be treated as the black sheep of the sector.

> Tony does not own any shares mentioned in this article.

Share & subscribe

Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

vinchainsaw 13 Nov 2012 , 6:11pm

PE of 11 means your understanding of "cheap" varies significantly from mine.

PE of 11 to me would mean fairly priced at best.

F958B 13 Nov 2012 , 8:39pm

vin

I agree.
11x is not a bargain; it's only slightly cheap - and in difficult times markets have been known to get a lot cheaper.

Late-1970's and early 1980's had a lot of companies with single-digit P/E ratios and dividend yields as high as the P/E ratio.

Given the once-in-a-generation global problems around today, I would not be at all surprised to see shares trade for similarly low P/E's and high yields, in a few years time, as governments continue to stumble and fumble their way along.

F958B 13 Nov 2012 , 8:43pm

I also think that Obama's deficits-as-far-as-the-eye-can-see (spending 1.5x what is received in taxes), and his anti-business and heavy-tax policies, and the Fed's Q-Eternity will cause serious problems for the US (and global) economy within a year.

TRhere 14 Nov 2012 , 10:09am

As the article points out, the PE is low compared to its historic trading range and sector peers.

Tony R

F958B 14 Nov 2012 , 10:32am

Hi TR

I suspect people thought the same in the late-1970's and early-1980's.
P/E ratios as a whole shrank from 25x to 8x in about 16years from 1966 to 1982.
Shares looked cheap around 1980, but the economic turmoil of the time drove them to such lows. I don't see why "this time is different".

At best, we have another decade or so of stagnation.
As Woodford said: "in coming years, growth will be hard to come by".
BOE governor King's recent speeches agree.

vinchainsaw 14 Nov 2012 , 11:10am

Tony,

I didn’t mean to denigrate your work whatsoever and was just making an observation. I enjoy your articles so please don’t take it the wrong way.

I agree the PE is low compared to historical ratios, but then historically the market was pricing in more growth for G4S, which was likely to come from continued growth in government contract bid success. Now that that is seemingly falling away it would stand to reason that the PE would contract.

As for my definition of cheap, I would venture and say BP, on a forecast PE of 4.5, is cheap. Really cheap actually. Cheap enough that I’m completely mystified as to why I haven’t bought any lately. But then that’s greed for you…

TRhere 14 Nov 2012 , 3:55pm

Vinchainsaw,

No offence taken! It's different views that make a market.

Tony R

Join the conversation

Please take note - some tags have changed.

Line breaks are converted automatically.

You may use the following tags in your post: [b]bolded text[/b], [i]italicised text[/i]. All other tags will be removed from your post.

If you want to add a link, please ensure you type it as http://www.fool.co.uk as opposed to www.fool.co.uk.

Hello stranger

To add your own comment, please login.

Not yet registered? Register now.