Capita plunges 40% to lowest this century

When Capita shares fall, they fall big, and today is no exception after this dire warning on costs.

A warning by Capita (LSE:CPI) that its turnaround will cost more than thought today shattered the mood of optimism in outsourcing after Serco (LSE:SRP) last week celebrated completing its own revival.

Shares in Capita tumbled almost 40% to less than 77p as the modest gains achieved since last summer's previous low below 100p unwound in spectacular fashion.

CEO Jon Lewis insists there's been significant progress in the restructuring, although from an investor viewpoint the stock remains below where it was prior to his “kitchen sinking” job of profits downgrade, rights issue and dividend suspension in January 2018.

Lewis said today that transforming an organisation of Capita's size was a complex challenge and that it would require more investment than envisaged two years ago. This is reflected in a new free cash flow target for 2020 of £160 million, compared with previous £200 million guidance.

The company still expects a return to modest organic revenues growth for the first time in five years, driven by efforts to simplify and strengthen the business and rebuild trust with clients.

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Analysts at Numis Securities said this was more optimistic than had been expected, although they cautioned that further exceptional items may still put pressure on profits. One-off items meant the company today recorded a bottom-line loss of £62.6 million.

Capita also appears to have dropped its target for double-digit operating margins, while the need for more investment means the City thinks net debt will rise not fall in 2020. 

The shares currently trade on a price/earnings multiple of 9x, compared with its peers on an average of 14 times. Numis has a price target of 205p, which is partly based on expectations for further non-core disposals to simplify the business and recycle capital.

They added:

“While a turnaround is proving more protracted than originally expected, progress is being made and the lowered guidance remains ahead of our forecasts and consensus.”

Other outsourcers have already gone down the same path as Capita, with Serco boss Rupert Soames recently able to declare a dividend for the first time in six years. Given how long it took for Serco to reach this point, today's announcement from Capita probably shouldn't come as a total surprise to investors.

Capita had been a favoured stock of City analysts and fund managers, including Neil Woodford, until it was forced into drastic action in order to protect its balance sheet. It hit trouble after placing too much emphasis on acquisitions to drive growth, rather than responding to new customer demands.

Lewis has met a number of key turnaround targets since then, including cumulative cost savings of £175 million over two years. Revenues growth was seen in four or the company's six divisions in the second half of 2019, with order intake reaching £2.2 billion in the year.

This includes from a drive to reposition Capita in more attractive areas, such as helping clients take advantage of business opportunities around 5G and the Internet of Things.

As well as rebuilding trust with clients, Capita is also seeing a positive change among its 61,000 strong workforce after employee satisfaction rose to 72% from just 56% two years earlier.