Stock of the day: Capita relapse looks temporary

Sentiment on Capita began to deteriorate again over the summer

Fear of faltering

Sentiment on Capita began to deteriorate again over the summer, so the outsourcing giant’s latest setbacks have resulted in another thumping for its shares. The group on Thursday reported let downs on revenues and outlook in the half year. In fact though, from the perspective of a dire last few years, things were looking up. And looking at the stock’s 33% rise in the year till end-June the market agreed. In June the group announced it had secured £318m contracts and extensions, with potential for more, including a possible customer services partnership with British Airways.

The stock’s slump by as much as 14% on Thursday reflects worries that a business rebound from a post-Brexit vote downturn could falter. Capita has followed a similar trajectory to rivals Serco, G4S and Babcock. All were caught in the political and economic crossfire linked to dependence on government contracts as public spending was squeezed, though they could have done themselves a favour by avoiding missteps.

CEO search “well advanced”

One source of the sharp investor reaction to Capita’s interim report could soon be neutralised. Following the ousting of 16-year incumbent Mike Parker in March, the CEO issue is on the verge of being resolved, if management comments can be relied on. Interim chief Mike Greatorex said on Thursday the search for a replacement was “really well advanced”. As for growth, whilst the group’s expectation of a modest rise in the second half has been interpreted as a small downgrade, it should hardly be a surprise after upside surprises earlier in the year, albeit the group needs another approach instead of silence on expectations for 2018.

The company has after all shown progress this year in simplifying a structure created during a highly acquisitive phase of expansion but which is no longer optimal. Underlying cash flow generation (£179m) was below the level reported at H1 2016 (£214m) as the group works through a six-way restructuring announced at the end of last year. But investors would be hard pressed to find faster operating cash generation amongst Capita’s well-matched rivals over 12 months. The group’s £479m trailing balance compares to £216m at Babcock and Serco’s minus £118m. Furthermore, Capita’s leverage is unwinding too, down 16% in H1 to about £1.6bn.

There’s no magic bullet for challenges UK outsourcing groups face, admittedly. Chiefly, the more demanding economic outlook and business process groups’ structural mismatch to face it. In Capita’s case, profitability remains, as does its 4.8% yield, at an undemanding 12.66 times forward rating. The yawning gap to Serco’s 44 times speaks to how convincing the latter’s reorientation efforts have been, even as its revenue trend remains soft. Yet it is Capita’s stock that has recovered the least amongst peers, remaining some 50% lower over two years. The new CEO, when she or he arrives, will have their work cut out, but the tools needed to engineer a bounce are in place.

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