Last week, the worst-performing stock in the FTSE 250 was Capita (LSE:CPI). The outsourcing company saw the share price drop 22% to finish the week at 21p. Over the past year, the stock is down 18% and is now at levels not seen since 1996.
It’s incredible to think that only in 2015 the share price was close to 800p. So at current levels, does it make sense for investors to buy?
The reasons behind the fall
For the past five years, the company has been experiencing declining revenue. Contracts have been harder to come by, both from higher levels of competition but also from some poor delivery from the business.
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Over the past year, the share price has struggled due to more unusual problems. For example, it was hit by a cyber attack in late March, with client data stolen. It has ultimately cost the business £25m to fix. This is an eye-watering number, especially considering the business posted a H1 loss of £67.9m.
In recent weeks, the fall can also be tagged to the exit plan from selling Agiito and Evolvi (the travel and event divisions). Both were profitable divisions and so I think some investors are concerned about selling areas actually performing well.
Looking forward, the main risks I see for the company are the revenue figures and also the operational inefficiency of the large sprawling business.
Look at the value
Despite the numerous headaches, I do think investors can find value in buying Capita shares now.
For a start, Capita is working hard to reduce debt levels. This has fallen from £710.4m a year ago to £544.6m now. The lower the level of net debt, the less worried investors will be about the company. This should help the share price to rally.
The selling of different divisions can also be seen in a positive light. Trimming the fat and becoming a leaner organisation should enable Capita to be more streamlined. With efficiencies comes cost savings. In this way, profit margins could grow.
Finally, the total contract value (TCV) at the end of H1 was £2.2bn, up 54% from the same period last year. This shows meaningful progress and growth.
The numbers are key
The falling share price has also helped to lower the price-to-earnings ratio. Using the last annual earnings per share figure, the ratio sits at just 3.27. Typically, any number below 10 represents a potentially undervalued stock.
For a stock to be trading at such a low multiple of earnings tells me a few things. It shows to me that investors don’t currently place much value on the business, or the future earnings. If they did, it would likely trade closer to 10x.
Yet isn’t this the basis by which value investors get excited? If everyone was expecting Capita to do well in coming years, there wouldn’t be much of an opportunity for a share price rally.
I’m not going to make out that the the share price is going to turn around today. Yet I do feel that if we revisit this article in a year, I’d be confident the stock would be trading higher than 21p.
