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Some of the biggest winners this year have been defence stocks. Babcock International and BAE Systems are leading the charge, up 130% and 65% respectively. But Chemring from the FTSE 250 has also rocketed 75% so far in 2025.
Another mid-cap stock doing well is Serco (LSE: SRP). Up 31% year to date, it’s now at an 11-year high!
Defence boost
Serco’s a government outsourcing specialist with fingers in many pies (transport, justice, immigration, hospitals, and more). But defence is the firm’s largest sector, now contributing around 40% of revenue. It does things like manage army bases, provide support for the Royal Navy, and run military training centres.
Yesterday (26 June), Serco released a stronger-than-expected update for the first six months of the year. Revenue is expected to tick up 2% year on year, while underlying operating profit will be at least £140m, with a “continued strong margin” of around 5.9%.
Order intake was robust, with around £3bn of contract awards, and a high weighting of those from the defence sector. The company also snapped up MT&S, Northrop Grumman’s mission training and satellite ground network communications software business.
This $327m acquisition enhances Serco’s presence in the booming North American and global defence markets. With rising military budgets, this could prove to be a canny purchase. It’s expected to deliver revenue of around £130m this year.
Looking ahead, Serco lifted full-year revenue guidance from £4.8bn to £4.9bn, boosted by higher-than-anticipated activity levels in the immigration sector. It expects underlying operating profit of £260m.
Two concerns
The stock looks fairly valued at 12 times forward earnings. There’s also a well-supported 2.3% forecast dividend yield too.
However, I have a couple of concerns that put me off here. First, the company’s forecast growth rates aren’t that high. The City sees revenue rising from £4.8bn in 2024 to £5.2bn in 2027. That’s a compound annual growth rate of about 2.7%.
In an era when both defence and immigration services are tipped for strong demand, I find that a little uninspiring. Then again, earnings are expected to grow 8% in 2025 and 2026, so the stock could easily keep chugging higher.
My second issue is that immigration services are a double-edged sword. On the one hand, Serco has vast experience housing and transporting asylum seekers, as well as running detention centres. These contracts provide steady cash flows.
The structural drivers for immigration and migration are clear, from climate change to geopolitical uncertainty, there will be and probably remain for many decades to come, high levels of migration in certain parts of the world.
Serco CEO Anthony Kirby, 2024 earnings call.
On the other hand, there’s the risk of reputational damage if allegations of mistreatment or poor conditions hit the headlines. That could jeopardise contract renewals and damage investor sentiment.
Should I buy Serco?
Weighing things up, I’m not going to add the stock to my portfolio. I’m happy with my current exposure to the defence industry. But this might be a FTSE 250 stock to consider for those who don’t want to invest in arms manufacturers.
Serco’s gaining exposure to rising global defence spending, which is one of the hottest trends in the market today, so the stock could have further to run.
