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I think this FTSE 250 stock is high risk, but is it high reward?

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Capita (LSE:CPI) is the major player in the UK’s outsourcing market. It is recognised as the largest business processing outsourcing and professional services company in the country. Capita’s clients include central and local governments as well as the private sector. 

Capita is not unfamiliar with controversy and poor performance. Is this stock worth a punt or is it one to avoid? For perspective, it is worth noting that the recent market crash saw near 60% wiped off its share price value. 

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Recent troubles

The last couple of years have been particularly tough for Capita. Back in 2018, following full-year losses of £513m, Capita launched a £700m fundraising campaign. At that point, the share price had seen a 70% decrease in the past year. 

Capita scrambled for these funds to avoid becoming a casualty of the government contractor crisis, like Carillion had just months earlier. 

The purpose of this money was to pay off climbing debts. Rising debt is always a red mark when I assess a company’s viability. Capital also needs to invest in technology as well as overseas growth, and to shift the group’s divisions to a more narrow focus. Rather than 40 divisions, Capita will narrow these down to software, HR, customer management, central and local government, and IT. 

If you were expecting to hear that 2019’s full-year results were better, based on the cash influx, you’d be disappointed. Capita reported a pre-tax loss of £62.6m, which was a huge drop from its 2018 profit of £272.6m. Even worse, its net debt rose from £466.1m to £790.6m. CEO Jon Lewis warned that more investment would be needed (which would ultimately require more fundraising) to continue the attempted turnaround. 

It sounds as though further injections of cash will be needed. Another red mark for me. Unfortunately, it seems Capita cannot curb its debt levels. 

There have also been revisions to previous guidance relating to the fundraising proceeds. The original £700m has been deemed not enough. The figure now stands at over £800m needed to continue plans. Most people understand market conditions change, but for me these are almost like broken promises. These are the types of issues that make me doubt Capita’s viability right now.

COVID-19 and next steps

A trading update provided at the end of March provided an insight into the impact of the coronavirus on Capita. The firm has been asked to assist in the government response to the pandemic, which is positive. There is also plenty of liquidity, as well as an order book totalling over £6bn, to see the company through the crisis.

Based on 2019 figures, Capita’s price-to-earnings ratio sits at below 3, which represents minimal risk. At the time of writing, the share price was trading at just over 40p per share. There is an opportunity here if you have a strong stomach and can handle some ups and downs. 

For me, however, Capita will be one to avoid just now. The recent climb in debt levels and the fact the company has admitted it will be seeking more funds to continue its rebuild are the major factors here. However, I do feel longer term there is an opportunity if things go right for Capita and its CEO’s plans. For that reason it will be one I will continue to closely monitor.

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Jabran Khan 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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