Capita crumbles again

Industry momentum remains soft and Capita has admitted that returning to sales growth will take time. Graeme Evans supplies the detail.

Having become one of the biggest corporate blow-ups of 2018, Capita gave value-hunting investors plenty to chew over today with half-year results showing a mixture of progress and continued huge challenges.

There's no doubting that chief executive Jonathan Lewis has stabilised the business since his spectacular kitchen sink job in January, when Capita's prized 7% dividend yield was axed and a £701 million rights issue launched.

The problems at Capita ran deep, with too much complexity and an outsourcing business driven by short-term focus and too little financial flexibility.

Crucially as far as investors are concerned, Lewis hasn't wavered from his key targets in today's half-year results. As well as tightening profits guidance for this year, he continues to expect £175 million cost savings by the end of 2020 alongside £200 million of sustainable free cash flow by the same year.

There are other positives too, including the expected proceeds of £416 million from disposals, compared with a previous target of £300 million.

But industry momentum remains soft and Capita has admitted that returning to sales growth will take time. Its order book at the end of June stood at £7.7 billion, compared with £8.2 billion in December, reflecting low levels of bid activity in 2017 and delays in decisions.

The company's operations now span six divisions, including government services, IT and networks and HR solutions.

While the plan is for a return to organic growth in 2020, Capita's warning of weaker growth in the second half of this year derailed recent share price momentum and left the stock trailing by 5% today.

The shares are now back where they were immediately after the January profits warning, having fallen as low as 128p in May. 

Whether this level is a good entry point or still a value-trap for investors remains to be seen. There are certainly encouraging soundbites from analysts, but with disclaimers that these are early days in the Capita turnaround.

Citi has a 200p price target and points to a reasonably solid revenue base into which the new management team can reconfigure the business.

Highlighting a 25% valuation discount to the rest of the business services sector, Citi said the "early stages of the turnaround narrative should encourage investors".

UBS has its 109p price target under review and admits it is hard to assess progress so far. However, analyst Rory McKenzie added:

"With disposals executed successfully and all other targets confirmed, we expect investors to be reassured somewhat today."

January's collapse in Capita shares wrong-footed many in the City, with only two out of 16 analysts having a ‘sell’ rating at the time and Neil Woodford’s Income Focus fund having only recently boosted its Capita exposure.

Woodford wrote a couple of days later that Capita represented "many of the things that this market loathes at the moment — it is exposed to the UK economy, it has a recent record of disappointment, it is an outsourcer".

Despite the slump, he backed the company’s new direction and said a decision to sell Capita shares was almost impossible to justify from a fundamentally-based perspective.

Woodford said in February: "I would go as far as to say that the business will be in better shape at the end of 2018 than it was in 2016.

"It will have infinitely better leadership, a stronger balance sheet, better cash flow, more conservative accounting policies and a lower pension deficit.

"The mistake I have made, albeit I didn’t know it at the time, was in owning Capita in 2016. It is not a mistake to own it now. And so, I will not be compounding the previous error by behaving in an irrational and valuation insensitive way now."