Capita Group — Capitalising on a more streamlined business

Research: Industrials

Capita Group — Capitalising on a more streamlined business

Capita faced numerous cash drags in FY23, notably £20m in costs associated with a cyber incident, a £30m pension deficit contribution and a £20m increase in technology capex, which depressed the adjusted free cash outflow before disposals to £116m (£42.4m outflow in FY22). Despite these challenges, the implementation of a rigorous cost efficiency programme and the strategic divestment of non-core assets have the potential to fuel a turnaround. Some £160m of annualised cost savings are expected to be realised by mid-2025 (part reinvested for growth), aimed at bolstering a significant improvement in operating margins. As margins improve, shifting to faster-growing market segments with a more competitive cost base could catalyse a reduction in the valuation discount.

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Industrials

Capita

Capitalising on a more streamlined business

Industrial support services

QuickView

7 March 2024

Price

15.7p

Market cap

£266m

Share price graph

Share details

Code

CPI

Listing

LSE

Shares in issue

1.7bn

Business description

Capita is a UK-based company that provides specialised consulting and professional delivery services in addition to digital services and solutions. It operates through two divisions: Public Services, which provides digital transformation to improve productivity and citizen experience of public services, and Experience, which provides cost-effective customer experience contact centres.

Bull

Contract wins with total contract value up 17% year-on-year.

Cost savings (+£60m annualised from Q124 and +£100m by mid-2025 with part of this reinvested for growth) are underway, which should support significant operating margin improvement.

Cessation of pension deficit contributions with effect from 2025.

Bear

Reduced contract renewal rate to 52% (FY22: 96%), reflecting loss of contracts on price, which will dampen organic revenue growth.

Negative free cash flow of £70–90m expected in 2024.

Risk of encountering service disruptions, unauthorised data breaches and the loss of vital customer data due to a cybersecurity incident.

Analysts

Natalya Davies

+44 (0)20 3077 5700

Andrew Keen

+44 (0)20 3077 5700

Capita faced numerous cash drags in FY23, notably £20m in costs associated with a cyber incident, a £30m pension deficit contribution and a £20m increase in technology capex, which depressed the adjusted free cash outflow before disposals to £116m (£42.4m outflow in FY22). Despite these challenges, the implementation of a rigorous cost efficiency programme and the strategic divestment of non-core assets have the potential to fuel a turnaround. Some £160m of annualised cost savings are expected to be realised by mid-2025 (part reinvested for growth), aimed at bolstering a significant improvement in operating margins. As margins improve, shifting to faster-growing market segments with a more competitive cost base could catalyse a reduction in the valuation discount.

FY23 faced with numerous obstacles

FY23 results appear severely depressed, affected by one-off items of £42m in goodwill impairment on business exits, £25m in cyber incident costs and £54.4m in cost reduction expenses, with EBITDA decreasing 39% y-o-y to £144.5m and a reported loss before tax of £106m (FY22 PBT: £61.4m). Nevertheless, these costs mask the underlying growth in contracts such as Personal Independence Payments, alongside a commercial settlement, with adjusted, continuing PBT increasing 14% y-o-y to £56.5m. The company saw sustained contract momentum, with a year-end total contract value of £3.1bn (FY22: £2.6bn); key contract wins include a 10-year contract to manage the Civil Service Pension Scheme and incremental scopes of work to deliver the FAS and the DSA.

The road to positive sustainable cash flow

Capita is undergoing a transformation phase, with the completed sale of its 75% stake in Fera Science for £62m in cash, marking the final disposal of the Portfolio division and enabling the streamlined business to focus on its two core divisions. In addition, in FY23 Capita paid £30m of regular pension deficit contributions and will pay a further £21m in FY24, with zero payments in FY25 and beyond. Its rigorous cost restructuring programme, which aims to save c £160m on an annualised basis (£60m to be delivered from Q124 and an incremental £100m by mid-2025, part of which will be reinvested for growth), should support significant margin recovery.

Valuation: Seeds sown for a potential recovery

A substantial downward trend in EPS has driven Capita’s share price to fall c 90% since January 2020, currently trading on a consensus 2025e P/E of 3.6x (a c 60% discount to peers). Its extensive cost restructuring programme, and now more streamlined business model, could catalyse a reduction in the valuation discount.

Consensus estimates

Year
end

Revenue
(£m)

PBT
(£m)

EPS
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/22

2,609

49.8

2.6

0.0

6.0

N/A

12/23

2,642

56.5

1.7

0.0

9.2

N/A

12/24e

2,707

79.3

3.3

0.0

4.7

N/A

12/25e

2,806

98.8

4.3

0.5

3.6

3.2

Source: LSEG. Note: Adjusted figures.

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This report has been prepared and issued by Edison. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

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This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

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Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

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