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Capita - Making Encouraging Progress

Capita reported their first organic revenue growth for six years when they reported HY numbers on 6th August. The transformation programme initiated by CEO Jonathan Lewis in 2018 is on the final lap. Stuart Morgan, Head of Investor Relations, gave an update on the company performance this year as presented at the half year results and outlined the opportunities ahead for the company at the latest Yellowstone Advisory webinar which you can watch here.

A lot of progress has been made in the first half of the year with the first reported growth in revenue for six years. Profits and margins were both up while net debt fell. The balance sheet will be strengthened further as more disposals are made in the second half and into 2022. The new organisation structure is now in place and the target is to generate sustainable free cash flow in 2022. Revenue performance in the first half was driven by winning new contracts such as Royal Navy training and not through Covid recovery, although the bounce back from Covid has started and led to stronger Q2 growth and is expected to benefit sales in the second half.

The company is more confident now about their ability to win contracts at attractive margins and in H1 won £2.6bn of business, an increase of 70% on last year. Capita has also invested in improving the service it provides to customers and saw this recognised in their net promoter score which improved by 39pts to 37. This is also reflected in the win rate on renewals which has increased to 89% and on new opportunities to 76%. This has helped the orderbook to grow by £1bn, the book to bill is 1.6x (although expected to be 1.3x at year end) and in addition the pipeline has also grown by c£2bn. The impact of organic revenue growth will come through in higher margins and profits.

Over the last 3 years Capita has made over £400m of cost savings which have been used to offset the decline in sales. As revenue increases the future cost savings will enable margins to increase further. £50m of cost savings are targeted in 2022 and this should fall straight to the bottom line. Margins will also be boosted by the closing out of the last remaining failing contracts which are either now exited or being finalised. In response to a question, Stuart commented that the property footprint will have been reduced by 25% by the end of this year, and the most expensive London property footprint is down by 60%.

Further on margins, the average net margin on new business is 11% and that includes the Army recruitment contract and the Royal Navy training contract which are both on mid/high single digit margins. A greater level of bidding discipline is being achieved which has resulted in over £400m of contracts turned down and a better appreciation of the risk/reward dynamics of each contract. Again, this discipline supports stronger margin progression.

The reorganisation of the Capita corporate structure is now complete, and the company now operates from two divisions: Public Services and Experiences. In the Public Service Division, the transformation is complete, and the division is growing revenues and profits strongly. It is the No.1 supplier to the government of digital services achieving revenues of £1bn and this is growing at 9% ahead of the market growth of 7%. As digital services grow, this should also have a positive impact on margins as this part of the business achieves higher margins. Growth is broad-based and they are winning business against a very accomplished competitor set. The pipeline of new business opportunities stands at c.£10bn and double-digit margins, similar to those achieved by other digital consultancies, are achievable.

The Experiences division is a little further behind in its transformation and needs some further work to be done. Profit and revenue growth in this division will not be as strong as the Public Services division. However, it remains the No.1 supplier of Customer Experience services in the UK and the No.5 supplier in Europe. The sector focus is in the telecoms, utilities and healthcare areas. The immediate focus is to continue to remove costs to become more competitive and invest in the digital platform to deliver services. The business does have attractive operating leverage though so as revenue improves and costs taken out, then margins should improve to high single digits once fully recovered.

On the balance sheet, £700m of disposals were targeted in 2021 and 2022 and they have already achieved three quarters of the target. The balance of £175m is targeted to be raised by the end of H1 2022. Businesses which generate £200m or revenues are for sale: BlueLight software and a specialist insurance business. Stuart reiterated he was confident they would achieve the £175m required. In response to a question, Stuart commented that there has been strong demand for the assets they are selling from both trade and financial buyers. The Revolving Credit Facility has also been extended by another year providing further liquidity to the balance sheet.

There are a further £350m of businesses which are for sale in the portfolio division. Some of these are good businesses but are non-core, others like the travel & Events and Enforcement are recovering from Covid. The objective for these businesses will be to exit by the end of 2022 and the proceeds from these disposals are expected to leave the company in a debt free position. To have an efficient balance sheet though the company might issue some debt and would target a net/debt to EBITDA ratio of 1-2x.

Finally looking at Free Cash Flow, the company expects to report sustainable free cash flow in 2022. This is after taking into account the cash payments for the pension costs and restructuring costs. In order for the company to return to the dividend list the company would need to have a stable capital structure and be generating sustainable free cash flow, both of which he expected to be achieved by the end of 2022 which means they could look at a dividend payment in 2023.

The presentation concluded with a summary: good progress has been made this year improving margins and profitability, the company has reported the first revenue growth for 6 years, the two new core divisions are operating well, the balance sheet restructuring is on track, and they could be debt free (pre IFRS 16) by the end of 2022 and the company will be generating free cash flow in 2022.

It doesn’t feel like very much of this progress is yet reflected in the share price.

A recording of the webinar can be found on the Yellowstone Advisory YouTube channel or by clicking here.

If you would like to receive information about future Yellowstone Advisory webinars, please email Follow us on twitter @ystoneadvisory.

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