Should I Invest in G4S?

LONDON -- To me, capital growth and dividend income are equally important. Together, they provide the total return of any share investment, and my aim is to invest in companies that can beat the total return delivered by the wider market.

To put that aim into perspective, the FTSE 100 has provided investors with a total return of about 3% per annum since January 2008.

Quality and value
If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value. So this series aims to identify appealing FTSE 100 investment opportunities, and today I'm looking at G4S (LSE: GFS  ) , which is the world's largest security-services provider. With the shares at 295 pence, G4S' market cap is almost 4.2 billion.

This table summarizes the firm's recent financial record:

 

2008

2009

2010

2011

2012

Revenue (millions of pounds)

5,929

7,009

7,258

6,966

7,501

Net Cash From Operations (millions of pounds)

373

509

448

372

287

Adjusted Earnings per Share

16.6

20.2

21.9

21.3

21.2

Dividend per Share (pence)

6.43

7.18

7.9

8.53

8.96

With more than 620,000 employees in more than 125 countries, G4S is a major employer and, undeniably, a business built around people, with all the unpredictability and challenges entailed. We don't need to look any further than the outcome of the firm's London Olympics contract to see how things can go wrong.

The firm provides outsourced security services for buildings, infrastructure, materials, valuables, and people, and it has been winning major contracts all over the world from both public and private-sector customers. During 2012 about 33% of revenue and 37% of profits came from fast-growing emerging markets. Although the company lost 70 million pounds on its Olympic contract during 2012, underlying earnings were slightly up on 2011. G4S has done a good job of growing its dividend, and I think that will be a big contributor to investor total returns going forward.

G4S' total-return potential
Let's examine five indicators to help judge the quality of the company's total-return potential:

1. Dividend cover: Adjusted earnings covered the recent dividend more than twice. Score: 4/5

2. Borrowings: Net gearing is 146%; net debt is around seven times normalized earnings. Score: 1/5

3. Growth: The firm has had growing revenue, flat earnings, and declining cash flow. Score: 2/5

4. Price to earnings: a forward 11 compares quite well to growth and yield forecasts. Score: 4/5

5. Outlook: Recent trading is mixed, and the outlook is optimistic. Score: 3/5

Overall, I score G4S 14 out of 25, which inclines me to be cautious about the firm's potential to outpace the wider market's total return going forward.

Foolish summary
High debt and wavering cash-flow can be a dangerous combination. G4S is growing its turnover, but the London Olympics debacle demonstrates that growth can lead to a loss of control. Underlying financial figures make sense if one-off losses prove to be just that. If such challenges should occur more frequently, underlying figures will be nonsense. In such a scenario, the firm's high debt could become unforgiving. For those reasons, I'm happy to remain out of G4S despite its forward dividend yield of about 3.4%. 

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