Capita Cashes In On Outsourcing

Published in Company Comment on 21 July 2011

Contract wins are on the up, but the shares fall.

I can remember when outsourcing started to become the rage. It was public services mainly, and we had bods at places like the NHS thinking "We don't need to waste our resources cooking inedible food for the patients if we can find someone who'll come in and cook inedible food for us cheaper".

It's extended to the private sector too -- it's a key part of Economics 101 that you do what you do best, and leave the doing of other things to those who do them better. Hard economic times can give a kickstart to the outsourcing process too, helping focus on the need to reduce operating costs.

Both of those trends have helped Capita Group (LSE: CPI), which bills itself as the UK's leading outsourcing company, to a pretty decent set of first half results, released Thursday.

Capita does some serious outsourcing -- it runs the BBC's TV license scheme, for example -- and has been enjoying a steady rise in profit for a number of years now. And, perhaps more importantly in these less speculative days, has been paying steadily growing and decently-covered dividends.

Growing profits

For the six months to June 30, Capita saw turnover rise by 3% over the same period last year, to £1.4bn, but what is more impressive is the company's underlying profit figures.

After accounting for some amortisation and acquisition costs, underlying pre-tax profit was up 7%, to £174m, while underlying earnings rose by 12%, to 22p per share. An interim dividend of 7.2p per share will be paid, which is a 9% improvement on last year.

Capita's operating margin, which is a key indictor for a company of this type, especially in tougher times, has been boosted from 13.1% at the halfway stage last year, to 13.8%.

Cash flow is down a bit, from £216m to £180m, but the company tells us this is due to greater demands on working capital as a result of new contracts and other projects. This impact should continue to the end of the year, but after that cash flow is expected to return to normal.

Acquisitions form a significant part of Capita's long-term strategy, and during the period a total of £194m was spent on snapping up 11 targets, with further shopping sprees planned for the second half of the year.

Growing demand

So what's behind the latest figures? Well, according to Capita, demand in both the public and private sectors is on the up again, and business has been boosted by a number of important contract wins. In the words of Chief Executive Paul Pindar…

"Against a backdrop of trading conditions which have continued to be challenging, the business has progressed in 2011 and we are now experiencing strong major contract sales performance and high levels of acquisition activity. We have secured contracts and renewals totalling £1.1bn in the first half of the year, more than double the value achieved in the first half of 2010. This reflects the increasingly strong demand for outsourcing across the public and private sectors after a 2 year period of subdued sales activity."

That has resulted in a bid pipeline of £4.7bn of potential business for Capita, amid reports of strong activity in central and local government, and the life and pensions market. We should hear of further bid outcomes in the second half of the year.

What's so good?

Apart from thinking the idea of outsourcing is generally a pretty good thing, I reckon the balance of Capita's work is probably about right.

A bit more than half is in the public sector, and involves pretty major stuff for central and local government, education, and health -- it's the big stuff that will remain in demand and which Capita is unlikely to lose if it keeps doing it right.

Other activities include life and pensions (Capita runs the Teachers' Pension Scheme), insurance, financial services, and transport, and Capita looks to be focusing on the big, long-term, things.

My cautious side is always somewhat averse to companies who target growth by acquisition, but I do like Capita's general focus on returning value to shareholders in whatever seems the best way at the time -- be that dividends, share buybacks (of which there were none this year so far), or whatever. But Capita's £1bn of net debt scares me a little, and I would like to see a more aggressive approach to paying some of it down.

Reaction

The market did not react enthusiastically, possibly because these figures are a little behind what would be needed to meet full year predictions of a 30% EPS growth, and possibly because of that debt figure, which is a quarter of the company's market cap. At the time of writing, the shares were down around 2%

But overall, Capita seems to me to be a well run, shareholder focused, company, looking to the long term.

Agree or disagree? Do tell us, below.

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Comments

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Philmoco 21 Jul 2011 , 12:48pm

If Capita is so well run why is it so heavily geared?
They don't need all of the debt to cover tardy client payment cashflow!
They've no capital assets of any substance, save their manpower!

Tykethat 21 Jul 2011 , 4:07pm

Alan,

You wrote, "But overall, Capita seems to me to be a well run, shareholder focused, company, looking to the long term."

I have to disagree, to me its run in a panic, couldn't care less about shareholders, and looks to the next set of figures it HAS to publish.

It has to keep attracting business at an ever increasing pace.... if it ever slows down ..... then it will be Oh Dear time very shortly afterwards

ANuvver 21 Jul 2011 , 4:13pm

Similarly concerned about the indebtedness.
But Polonius would have had trouble in this day and age.

"Neither a borrower nor a lender be,
Unless inflation be on the increase,
and Moody commendations
do masters of the marketplace
great enterprises make."

Apologies to Bill S

ANuvver 21 Jul 2011 , 4:21pm

Oh, and surely Capita's business model is all about hauling as much transaction process as it can over to Direct Debit as quickly as possible. At which point the whole thing can be run by R2D2.

Not so good from a customer perspective, but pretty sound business strategy.

TMFBoing 21 Jul 2011 , 7:00pm

I'm actually in two minds about the debt/gearing.

Instinctively I don't like it.

But if you can exploit it during tough times to get ahead of the competition (and there does seem to be a decent amount of outsourcing business out there for those who can competitively tender for it right now), then you could end up well ahead when we're back to decent economic growth (which we will be).

Best,
Alan

eccyman 21 Jul 2011 , 8:05pm


There's a flaw in their argument of "Leave activity XYZ to a specialist outsourcing company like Capita". How does Capita manage to be a "specialist" in so many varied areas?


I'm pretty cynical of the whole outsourcing business, it's mainly a fad driven by the that bete noire of investors - the management consultants.

Like all fads, the outsourcing fad will fall out of favour one day....


ANuvver 22 Jul 2011 , 12:50am

The most dangerous five words:
"Leave it to the experts."

Off the top of my head: time and motion, total quality management, ISO9000+, adding value, GANT, synergy generation, process reengineering...

I'm always amused by the latest crap to come out of Harvard, Cranfield or wherever.

Fads, indeed.

mackeson29 25 Jul 2011 , 9:30am

'How does Capita manage to be a "specialist" in so many varied areas?'

By being spread out in 'satellite' locations as subsidiaries - It is not one place/building that covers all its myriad of pies. Each small 'subsidiary' handles its own niche - for instance the software division nestles on its own & merely reports to HQ in London for top level matters. Therefore that division gets to concentrate on their 'expertise' area, employing the best people for that job.

I understand the sceptisism of outsourcing, however when it comes to stuff like software for schools, would you prefer it to be done by the schools themselves or even the local education authorities ? Does your company write all its own software, or do you buy in packages for accounts, etc ?

Its not all about the london congestion charge....

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