Shares of security group G4S (LSE: GFS) edged lower this morning, despite the firm reporting a 19% increase in earnings per share for 2017. Having combed through today’s figures, is the market’s sceptical reception justified, or is it finally time to turn bullish on this battered outsourcing giant?
G4S shares have fallen by 25% since last summer as a result of concerns about the outlook for the outsourcing sector and worries about the firm’s debt levels and growth prospects. More recently, investor confidence was shaken following a BBC exposé of abusive staff behaviour at a Gatwick immigration centre run by the firm.
However, the group’s increased focus on cash handling and security technology is seen as a positive move. Over time, analysts expect this strategic shift to result in much lower staffing costs and higher, more stable margins.
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A reassuring set of figures
Today’s figures suggest to me that concerns about G4S’s outlook could soon start to fade. The group’s revenue rose by 3.1% to £7,828m, while the firm’s measure of adjusted operating profit rose by 6.5% to £491m. Importantly, profitability also improved — adjusted operating margin rose from 6.1% to 6.3%.
The company also scored highly using one of my preferred measures of profitability, return on capital employed (ROCE). This compares profits with the capital invested in order to achieve those profits. My calculations suggest that the group’s ROCE was 16.7% last year, up from 14.3% in 2016.
A figure of more than 15% is generally seen as quite high so G4S does seem to be well on the way to becoming a highly profitable business.
Debt and the dividend
One of the group’s big challenges over the last few years has been debt reduction. G4S’s net debt peaked at almost £2bn in 2012, when profits collapsed following the London Olympics security fiasco and other problems.
Although free cash flow fell from £394m to £376m last year, the company was still able to repay some of its borrowings. Net debt fell by 11% last year, from £1,670m to £1,487m. This reduced the closely-watched net debt/adjusted EBITDA multiple to 2.4x, below the board’s target of 2.5x.
This level of borrowing is still uncomfortably high, in my view, but it should be manageable and shouldn’t threaten the dividend.
Indeed, having achieved its leverage reduction target for the year, the board has recommended a 5% increase in the final dividend. The total payout for the year will rise by 3.1% to 9.7p per share. This gives the stock a tempting yield of 3.8% at the last-seen price of 253p.
A stronger outlook
Analysts’ consensus forecasts for 2018 suggest that the group’s adjusted earnings could rise by 10% to 19.7p per share. A 4% hike to the dividend is also expected, lifting the payout to about 10p per share.
These projections put the stock on a forecast P/E of 12.8 with a yield of 4.0%. Given the group’s improved financial strength, I think the shares could be a profitable long-term buy at current levels.
