Contrarian investors buying into a recovery at outsourcer Serco (SRP) had their fingers badly burned as new chief executive officer (CEO) Rupert Soames flags £1.5 billion of asset impairments in coming years. That sent the share price plunging, falling more than 31% to 217.8p.

Serco has the most negative ratings among analysts of almost all FTSE 250 stocks, with an I/B/E/S score of 3.4: the closer the number is towards five, the more unfavoured the stock. Today, they were proved right.

In an unscheduled announcement, Serco revealed cost over-runs on a naval ship maintenance project in Australia and government contracts in the UK mean it will need to set aside £450 million to cover expected losses in these businesses.

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Serco is also writing off £500 million of investments previously made in its private sector operations, the Global Services Business Process Outsourcing division, as it refocuses on government-only operations. But Soames says parts of this business may be valuable to other contractors and could be sold off.

Specifics on the remainder of the impairments are as yet unconfirmed.

Analysts at Investec Securities say today’s news ‘underlines the extent of the issues within this business at present’.

‘There is a lot to absorb today, but it is important to note this might not be the end of the bad news and that any turnaround is going to be a long process,’ the analysts add. Investec has a ‘sell’ rating on the stock.

Shares also highlighted the risks at Serco earlier this year.

Expected losses on these contracts will impact agreements with the company’s lenders. Bank debt at the year-end is expected to be between £650-750 million and, with earnings before interest, tax depreciation and amortisation in 2015 expected to be £160 million. Net debt to EBITDA, a key financial ratio would be, 4.4x, well ahead of Soames’ target level of 1-2x.

Soames says he will open negotiations with lenders but that a rights issue will likely be required in the first quarter of 2015, at a value of around £550 million.

Issue Date: 10 Nov 2014