Government Insourcing Trends Will Curb Contract Wins Despite Strong Orders

Key Takeaways

• Heightened government scrutiny, insourcing trends, and rapid technology adoption threaten contract visibility, margins, and long-term revenue stability.
  
• Heavy sector and geographic concentration, plus reputational issues, increase vulnerability to policy shifts and limit profitable market expansion.
  
• Robust contract wins, favorable industry trends, digital transformation, and targeted acquisitions support strong growth, increasing revenue visibility, margin expansion, and financial flexibility.

Catalysts

Provides public services in the United Kingdom, Europe, North America, the Asia Pacific, and the Middle East.

• The growing tendency among governments to reassess the risks of outsourcing critical services-driven by increased geopolitical instability and national security concerns-raises the likelihood of large-scale insourcing and the cancellation of key contracts. This would directly impede long-term revenue growth and undermine the high visibility of Serco's contract pipeline, resulting in lower top-line expansion and future earnings.
  
• Mounting public scrutiny and political opposition to outsourcing in sectors like justice, immigration, and defense creates potential for abrupt regulatory clampdowns or contract renegotiation. Such developments could sharply constrain contract margins and damage Serco's ability to retain or win new government work, putting sustained margin expansion and profitability at risk.
  
• The continued rapid advancement of automation, artificial intelligence, and digital government initiatives allows governments to bypass third-party service providers. If governments adopt these technologies in-house, Serco could lose major contracts or face significant pricing pressure, leading to erosion of recurring revenues and compression of net margins over time.
  
• Heavy concentration of revenues in specific regions and sectors, such as defense and government contracts in the UK, North America, and Australia, amplifies exposure to policy reversals and cyclical government spending cuts. Any shift in political priorities or defense budgets could drive unexpected revenue volatility and sharply reduce earnings predictability, despite the appearance of a robust pipeline.
  
• Persistent historical reputational risks-stemming from legacy contract issues-are likely to intensify compliance demands and heighten barriers to new awards as governments favor competitors with clean track records. This could result in higher operating costs and limit Serco's ability to participate in, retain, or profitably expand into new or existing public service markets, ultimately dampening long-term earnings growth.

Serco Group Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Serco Group compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Serco Group's revenue will grow by 2.9% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 1.0% today to 3.5% in 3 years time.
• The bearish analysts expect earnings to reach £184.0 million (and earnings per share of £0.19) by about August 2028, up from £48.6 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 8.1x on those 2028 earnings, down from 45.5x today. This future PE is lower than the current PE for the GB Commercial Services industry at 27.2x.
• Analysts expect the number of shares outstanding to decline by 6.2% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.77%, as per the Simply Wall St company report.

Serco Group Future Earnings Per Share Growth

Risks

• The company's record order intake, high contract retention rates reaching 95%, and a book-to-bill ratio above 130% provide strong future revenue visibility, making a sustained decrease in share price less likely as these factors directly underpin ongoing top line growth.
  
• Secular tailwinds such as rising global defense spending and persistent government outsourcing are reflected in a pipeline that's the largest in over a decade, especially in North America and Europe, which may drive revenue and operating profit materially higher over the long term.
  
• Success in digital transformation initiatives (automation, AI, and technology-enabled solutions) is leading to improved contract wins and higher efficiencies, which could structurally enhance Serco's net margins and support margin improvement in underperforming geographies.
  
• Strategic bolt-on acquisitions-such as the MT&S acquisition-are broadening Serco's capabilities in high-growth segments like synthetic training and space, boosting both organic and inorganic growth, and increasing recurring earnings through diversification.
  
• The company's strong balance sheet (leverage below 1x EBITDA, with regular surplus cash returned to shareholders via dividends and buybacks) and a capital-light operating model enhance financial flexibility, supporting future earnings stability and attractiveness for shareholders.

Valuation

• The assumed bearish price target for Serco Group is £1.42, which represents two standard deviations below the consensus price target of £2.3. This valuation is based on what can be assumed as the expectations of Serco Group's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of £2.81, and the most bearish reporting a price target of just £1.4.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be £5.3 billion, earnings will come to £184.0 million, and it would be trading on a PE ratio of 8.1x, assuming you use a discount rate of 7.8%.
  
• Given the current share price of £2.19, the bearish analyst price target of £1.42 is 53.8% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.