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Should you snap up Capita plc after 50% slump?

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The demise of outsourcing firm Carillion sent shivers through the whole of the industry, and the panic slump in world stock markets which hit the FTSE 100 hasn’t helped.

The combined effect has been to pummel Capita (LSE: CPI) shares even harder, and we’re looking at an 85% price crash since a peak in July 2015. In fact, Capita shares haven’t been as low as this since the start of 2003.

What’s going to happen next? A promising recovery play, or the same risk that I think I’m seeing in sector rival Interserve?

I don’t like the look of Capita’s current liquidity one bit. At 30 June, net debt stood at £1.6bn, and the company told us that “adjusted net debt-to-adjusted EBITDA at 30 June 2017 is 2.86.” That’s not good, especially as free cash flow had fallen by 16% since a year previously, to £179m, even while adjusted pre-tax profit was up 46%.

In fact, that debt-to-EBIDTA is worse than Interserve’s at the same time, which reportedly stood at 2.5 times. And that’s a company about which the government is apparently worried and which its experts are closely watching.

Capita decided to maintain its interim dividend at 11p per share at the time — and that’s after several years of rises, during which time the hole it is in was getting deeper. I don’t understand companies that keep paying dividends while debts are mounting and cash flow is weak.

New start?

Thankfully that mistake was rectified by new boss Jonathan Lewis, who has plans for transforming the company. An update on 31 January told us that “Capita has commenced a multi-year transformation programme and is committed to delivering a strategic review of the Group during 2018.” Part of that is a suspension of the dividend until the firm can achieve sustainable free cash flow.

To get the balance sheet back in order, there are also going to be some non-core disposals, and there’s a rights issue planned for 2018 to raise some much-needed cash. Quite how much dilution we’ll see is not yet known, but there’s “standby underwriting in place for up to £700m.

That’s all well and good, but I find myself asking the same questions I ponder every time I see a company getting into such a horrendously cash-strapped position. Why have they only just spotted it now and why didn’t they do something about it sooner? I don’t know the answer, but I do know that it’s the shareholders who suffer from such a blinkered approach.

The immediate result of that announcement was a further share price fall — apparently an “oh, things really are as bad as they looked” moment.

Contagion?

So is the whole sector a basket case? Not a bit of it, and to me this looks like an opportunity to invest in some depressed competitors at attractive prices.

Mitie Group (LSE: MTO) might be worth a look right now, with its shares on forward P/E multiples of around nine and falling. The share price has shed 45% since June 2017. September net debt stood at £173m, which looks manageable, and the forecast 2.5% dividend yields are very well covered.

Capita might turn itself around, but with P/E ratios of around five, a lot of investors are pricing the shares to go bust. I hope I’m wrong, but I’m not buying.

Bargain stocks to buy now?

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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.