Why I would prefer this falling knife over Boohoo.Com plc


Public services company Serco Group(LSE: SRP) is flying this morning, its share price up 9.28% at time of writing after its latest trading update. The statement, published ahead of its Capital Markets Event for institutional investors and analysts, offered positive profit guidance with 2017 expected to be around the top end of its previous guidance range of £65 to £70m. That is around 10% higher than in the comparable period in 2016. 

Made to order

Serco's closing net debt is expected to be towards the lower end of the previous guidance range of £150m to £200m, which makes a killer combination. Management also reported a strong order intake of over £3bn, which represents a book-to-bill ratio of over 100%, its first since 2012. It anticipates strong profit growth in both 2018 and 2019, with growth thereafter dependent on market demand reverting to trend.

The £1.14bn group's order intake includes Grafton prison in Australia, its largest ever win, as well as other new contracts for Southampton NHS Foundation Trust, the US Army Installation Management Command and the US Navy Fleet Readiness Centers, among others.

Pipeline pain

Revenue for 2017 should come in at just under £3bn, a small reduction against previous revenue guidance, largely due to adverse currency movements and other volume and timing effects. Management also warned that some markets, particularly the UK, are growing more slowly although it can partly compensate by cutting costs.

Investors in this former falling knife deserve some respite as Serco's share price is trading 78% lower than five years ago, with profit warnings in 2014 and 2015 hitting it hard. Its stock suffered again in November when it withdrew bids for light-rail franchises in the Middle East, shrinking its bid pipeline of large contracts by almost a third.

Cry babies

Serco's fightback has a long way to go still, given disappointing free cash flow, no dividend and continuing debt, with City analysts forecasting a 63% drop in earnings per share (EPS) this year, followed by a 37% rebound in 2018. However, long-term investors may benefit from investing ahead of the recovery although some may prefer these two bargain stocks that could make you rich.

While Serco is generating excitement today, I suspect the glory days may be over for fashion e-commerce leader Boohoo.Com(LSE: BOO). Its stock is up an incredible 403% over the past two years but its share price has fallen more than 30% in the last three months.

Pretty vacant

What comes up also goes down, often at a similar speed, and with the stock currently trading at a whopping 78.8 times earnings, that time could be now. There is nothing particularly wrong with the underlying business, which has supplemented its range of brands with acquisitions PrettyLittleThing and Nasty Gal, simply that market expectations have become overstretched.

EPS growth of 48% in 2016 and 97% in 2017 are forecast to modify slightly to 27% and 28% over the next couple of years, which is still growth to die for, but maybe not at today's valuation. Last time I looked at the stock, in September, it was trading at a whopping 113 times earnings and I am glad I urged caution given its subsequent plunge. Sometimes you have to admit you have come to the party too late. With Serco, the party may just be getting started.

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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has recommended boohoo.com. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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