Why I think the Capita share price could be one of the top recovery buys in 2020

The Capita share price makes me think the company is priced to go bust. But its balance sheet convinces me it won’t. I’m seeing a recovery bargain.

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Capita Group (LSE: CPI) has been something of a tragedy for investors, with the share price having lost 95% over the past five years. Who needs a global pandemic to destroy shareholder value? Well, Covid-19 hasn’t helped, and most of what little value was left in Capita shares at the beginning of the year has evaporated in the 2020 crash.

Half-year results released Tuesday did nothing to lift investors’ hearts, sending the Capita share price down more than 20% during the morning. As I write, on Tuesday afternoon, the price has pulled back a little. But I’m still sitting here looking at a 15% loss on the day.

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Only eight days previously, Capita had revealed an extension to its contracts with Transport for London. The deal, worth £355m, will see Capita continuing to operate London’s Congestion Charge, Low Emission Zone (LEZ), and Ultra Low Emission Zone (ULEZ) from October 2021 to October 2026. There’s some new work included too, so all looks good on that job.

As a result, the Capita share price looked like it was turning tentatively upwards. But that’s already history, as Capita told us that profit in the first half has been “significantly affected“. It added: “The delay in the return to growth means we will not generate sustainable cash flow for 1-2 years“. 

I’ve been bearish on Capita for some time, as the whole outsourcing sector has been reeling from blow after blow. The collapse of Carillion exposed the flimsy financial foundations of the industry. And since then, many competitors have barely been hanging in there. But, you know, I’m really starting to wonder whether Capita might just be a worthwhile recovery candidate.

Priced to go bust?

On current forecasts, the Capita share price suggests a price-to-earnings ratio for 2021 of just 3.5. Now, a 2021 forecast is especially vague in the current circumstances. But it’s a valuation level that has a lot of safety margin built in. If the Capita share price were to quadruple, it would still only reach around the long-term FTSE 100 average. At today’s Capita share price, I see the company as priced to go bust. So the key question is what does liquidity look like?

Net debt stood at £1,096.6m, and that’s actually down from a 31 December figure of £1,353.2m. The company says it has liquidity of £704.1m, which includes £117.3m benefit from a VAT deferral scheme. The firm is undergoing some simplification and restructuring, with disposal proceeds going towards strengthening the balance sheet.

Though Capita reported a pre-tax loss of £28.5m, it put its adjusted figure at a profit of £30.1m. That’s way below 2019’s £117.8m, but it’s positive, and I see that as crucial. Adjusted cash from trading operations was put at £193.3m.

Capita share price potential

I reckon I’m seeing a company valued based on short-term fears and a year of earnings that are all but wiped out. But I think that misses the long-term recovery potential here. I really think the Capita share price could be significantly higher in a few years’ time.

Right now, I’m still held back by my first rule of recovery investing. That’s to hold off until I see convincing signs of recovery really happening in a company’s fundamental performance. Perhaps that’s being unnecessarily cautious. But I’ll be watching Capita closely for such signs.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Should you invest the value of your investment may rise or fall and your Capital is at Risk. Before investing your individual circumstances should be considered, so you should consider taking independent financial advice.

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