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What I’m doing with the bargain Capita share price

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I think the Capita (LSE: CPI) share price looks like a bargain at current levels. This is based on its potential for growth over the next few years. 

Growth outlook

During the past five years, Capita has encountered problem after problem. Many of these issues were of the company’s own making. The outsourcer consistently underbid for contracts in the past, which meant it had to cut corners to improve profits.

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Ultimately, the group couldn’t keep this charade up forever. In 2016 and 2017, operating losses totalled nearly £500m as the group tried to correct past issues. Since then, the firm’s been shrinking.

Revenues fell to £3.3bn in 2020, down from £4.7bn in 2015. Management’s been selling off non-core businesses and exiting unprofitable contracts to improve overall performance. This has had an impact on both the top line and the Capita share price. 

However, the company believes it’s now put the worst of its problems behind it. In its full-year results release, the firm said it expects to return to organic revenue growth this year and achieve sustainable cash generation in 2022. If the group manages to meet these aims, I think it’ll mark the successful conclusion of its multi-year turnaround plan. 

This, in turn, could translate into a re-rating of the stock. At the time of writing, shares in the outsourcing business are changing hands at a forward P/E multiple of 6.9. That’s compared to the market average of around 17. I think this low multiple shows what the market thinks about the firm. It doesn’t trust the company, and that’s understandable considering its past. 

But, if the group does return to growth, I think it’s not unreasonable to say the Capita share price deserves a higher multiple. 

Of course, these are only projections and estimates at this stage. There’s no guarantee the firm will be able to return to growth next year. And there’s no guarantee City analysts are correct in their estimation of how the company’s earnings will evolve over the next 12 months.

Capita share price challenges

If the firm runs into significant problems with historical contracts, which it has done in the past, this could derail its recovery. In this situation, investors may desert the Capita share price once again. 

There’s also the issue of debt. Capita has been trying to reduce its borrowings for the past five years. It has succeeded to a certain extent. Net debt has declined from around £2bn in 2015 to £1.1bn at the end of 2020.

Unfortunately, this level of borrowing still looks high compared to the company’s market capitalisation, which stands at £780m. Creditors have been happy to support the corporation up until this point, but there’s no guarantee they’ll stand by the business forever.

Despite the risks and challenges the company faces, I think the Capita share price looks cheap. That’s why I’d buy the stock today as a recovery play within a diversified portfolio.

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Rupert Hargreaves 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.

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