Capita kitchen sinks (again)
Capita has become another lightening rod for misgivings about outsourcing and public-private finance. Shares in the FTSE 250 stock crashed 45%—wiping out £1.3bn of value—after ‘kitchen sink’ announcements on profits, the dividend and a rights issue.
New CEO Jonathan Lewis said on Wednesday: "We cannot continue to focus on the incredibly broad array of disparate businesses…The strategic review we're undertaking will cause Capita to shrink, cause Capita to focus.” The comments were no big departure from the board’s strategy of the last several months. However, the group was signaling willingness to grasp the nettle more firmly. The £700m rights issue planned, disposal of some assets and scrapped pay-outs will stabilize its balance sheet. Leverage is anticipated to fall to 1.2 times core earnings compared to 2.25 times level at present. A signal on pension deficit reduction is also welcome.
Capita is not Carillion
An important difference between Capita and Carillion though is that the latter’s problems are linked to under-bidding on major contracts but Capita’s originate in routine services. Capita specialises in IT solutions for banks, the National Health Service, retailers and other sectors. Its string of profit warnings over the last few years stems from clients delaying new deals after Britain's vote to leave the European Union. Consequently, the group has been forced to undertake a painful process of simplification. It had previously depended on acquisitions as the main driver of revenue for years.
Another key difference between Capita and Carillion is that Capita generates lots of cash. It ended its last full year with £408m. On that basis, insolvency does not beckon for Capita. However the group is still subject to the same concerns as Carillion. Namely low- (or even zero) margin for contracts for increasingly cautious businesses amid political risk.
The ‘unknown’ could assail Capita as savagely as Carillion too. Most of its non-current assets were intangibles at the end of 2016 and two-thirds were ‘goodwill’ linked to acquisitions. These were the last reliable accounts of assets and liabilities before the group began a root and branch review.
Banks won’t ‘sell-out’ but more investors will
So, to be clear, Capita’s lenders will remain on side whilst it keeps generating cash and staying within leverage limits—as it has done to date. Beyond those limits, its future is uncertain. For that reason, we think stock price support will be less evident for Capita than selling interest for the foreseeable future. With 4% of shares out on loan, according to FCA data, Capita is a big short. Flimsily positive news could trigger a rush for cover, and an upward spike. The stock is down 84% in two years, near 15-year lows, and certainly oversold. However, we still expect any bounces to be sold, until the group can offer more clarity on growth and profits.
StoneX Financial Ltd (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.
No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.