Shares in outsourcing firm Mitie Group (LSE: MTO) fell by as much as 20% this morning after the group issued its second profit warning in three months.
The group plunged to a £100.4m loss during the first half of the year, after deciding to sell or wind down its home carer business, due to falling volumes and increasing price pressure.
Mitie shares have since recovered some of their early losses, and are now down by about 10%. But the outlook remains uncertain for the group, which has lost more than 40% of its market cap this year.
In this article I'll ask whether today's news could mark the low point for Mitie. Is this stock a turnaround buy, or is there better value elsewhere in the outsourcing sector?
Mitie employs a high number of low-paid workers in sectors such as cleaning and security. The national living wage has caused costs to rise for the firm's clients, some of which have cut spending as a result.
This has translated into flat revenues and lower profits for Mitie. The group's adjusted operating profit fell by 39.1% to £35.4m during the first half, pushing down Mitie's adjusted operating margin from 5.2% to 3.2%.
Adjusted earnings per share fell by 44% to 6.2p, and Mitie confirmed that full-year earnings are now expected to be below previous forecasts. The interim dividend has been cut by 25% to 4p. This suggests to me that the forecast full-year payout of 11.8p is unlikely to be met.
Has Mitie bottomed out?
Ruby McGregor-Smith, Mitie's chief executive, is leaving the group in December. She'll be replaced by Phil Bentley, who was previously in charge at Cable & Wireless and British Gas.
Mitie's management expects second-half results to be better, as a result of cost-saving measures and revenue from certain new contracts. In my view, this isn't a good enough reason to buy. I suspect further problems may come to light after Mr Bentley takes charge. I believe it's too soon to consider Mitie as a recovery play.
Don't lose hope
Mitie shareholders shouldn't lose hope. The recovery of Serco Group plc (LSE: SRP), under replacement chief executive Rupert Soames, suggests that Mitie's outsourcing business model remains valid.
Mr Soames has managed to dispose of or terminate many of the group's lossmaking contracts, in order to focus on more profitable work. Serco's net debt has fallen by more than half over the last year. The group's underlying first-half earnings rose from 1.57p per share to 3.7p this year.
Although Mr Soames has warned that further gains may take longer to deliver, he does appear to have stabilised Serco. The firm's shares have recovered some of their previous losses, and are up by 37% so far this year.
Serco currently trades on a 2016 forecast P/E of 30, and offers no dividend. This may seem pricey, but at 136p, the stock is cheap relative to historical earnings. For investors with a long-term view, Serco may be worth a closer look.
Is this today's top recovery buy?
Rising costs in the outsourcing sector may continue to put pressure on profits. But our expert analysts have identified a company where profit margins may be poised to rise. They believe shares in this company could be significantly undervalued at current levels.
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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.