Last week Serco Group provided an update on its H1 2014, at the start of its close period before the results on August 12, 2014.

Overall performance is in line with the guidance for H1 2014 given in the market update two months ago, of

• Adjusted revenue of ~£2.4bn, broadly flat y/y on an organic basis
• A significant y/y decline in margins, with an improvement expected in H2.

Over £2bn of contracts have been awarded during the period.

The company is in the middle of conducting a strategy review which includes:

• An assessment of markets, value proposition, organization and structure.
• Analysis of loss-making contracts: provisions of around of £10-15m are likely in the U.K. business, particularly related to the COMPASS program (provision of accommodation and support services for asylum seekers) and clinical healthcare contracts
  • The COMPASS contract is now expected to be loss-making over its five-year life.  The contract has incurred a cumulative operating loss of ~£15m since it started in late 2012.  An provision for future losses is expected to be charged in H1. 
  • Serco made £18m of exceptional contract provisions in 2013 for underperforming clinical healthcare contracts (principally the Suffolk Community Healthcare deal); a further exceptional charge is likely to be made in H1.

The following day Serco heard it had lost the Docklands Light Railway franchise, a franchise it has held for 17 years. On the face of it, this was another body blow to the company: the franchise contributed ~2% of its overall revenue in 2013. However, this was a margin dilutive business - its loss may not be such bad news after all.

Serco is facing challenges elsewhere in its U.K. rail operations business: it also announced last month that is competing against current partner Abellio for the next Northern Rail franchise period from February 2016. But elsewhere, it was successful in its bid for the 15-year franchise to run the Caledonian Sleepers service for Transport Scotland.

Under its new CEO Rupert Soames, Serco is already making some radical changes, for example an organizational restructuring of its AMEAA division announced last month (see http://research.nelson-hall.com/search/?avpage-views=article&searchid=27967&id=203066&fv=2 . He is also starting to deal with some problem areas: the company has made a few small disposals of unprofitable and/or problematic businesses, for example Braintree Community Hospital clinical health services.

Over the next year there could possibly be some rationalization of what is a very broad global portfolio.

Serco went through a torrid year in 2013 but it is not to be discounted: it is a major player in the U.K. government and rail sectors, and it is winning new business in the U.S. and Australia. Once the strategic review is completed, there will be more clarity about next steps in the group strategy.