Capita (LSE: CPI) shares have recently caught my eye. The FTSE 250 company is currently very cheap, with a P/E ratio of 4x, even after a 30% rise in just a month. But while Capita shares maybe a bargain, they come with considerable risk.
Prior to the pandemic, the share price was hurt on the back of its rival Carillion’s collapse in 2018. The outsourcing sector has suffered since then and the Capita share price has struggled with it. A string of profit warnings have added to its woes and despite its recent rise, the share price is down 63% over 12 months.
New CEO, Jonathan Lewis joined Capita in 2017 to turn around the company’s fortunes. But do I feel it has turned a corner under his leadership? Not yet!
What does Capita do?
I must admit that Capita can be a hard business to understand. I think the problem is that the company has its finger in so many pies that it’s really difficult to know what’s going on.
In a nutshell, Capita is a consulting, digital services and software business. At least this is how it describes itself on its website. It’s also an outsourcing firm that operates both in the public and private sectors.
It has six divisions and revenue from each business is relatively evenly distributed. While the business is somewhat complex to understand, at least it has diversified its revenue, although some might say it’s too diversified.
Strategy
When Lewis took over as CEO he concluded that Capita worked across too many markets and services. I agree with this point. In fact, I think it’s very difficult to maintain a competitive advantage in every business.
Lewis also pointed out that Capita had relied too much on acquisitions to drive growth and had also seen weakness in the quality of new contracts. His strategy is very simple. It’s to simplify the portfolio of businesses, focus on higher-quality contracts and strengthen the balance sheet. But I think this is easier said than done.
This means that there have been disposals of businesses and the proceeds have been used to strengthen Capita’s financial position. The funds will be used to reduce the large net debt position and pay down pension liabilities. I think it’s encouraging to see Capita reduce its leverage, but this will take some time to yield results.
Recent events
Capita has struggled during the pandemic. Revenue was not only hit by Covid-19 but also by 2019 contract losses. Yet the shares have risen on the recent flurry of positive news. It has signed a contract to deliver training services to the Royal Navy. Last month, Capita completed the sale of its Education Software Solutions business.
It also recently confirmed media speculation that it’s looking to sell its AXELOS business. This is a joint venture with the UK Cabinet Office where Capita owns 51%.
What next for Capita shares
There are a few bright spots for the company. The disposing of assets means that the debt pile can be reduced faster. Capita has also focused on securing higher- contracts as evidenced recently with the Royal Navy. This could mean a brighter future for the firm. Yet I think it’s still early days and there’s no guarantee that the turnaround will be successful. For now, I’ll sit on the fence and monitor the shares.
