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Capita is a consulting, transformation and digital services business listed on the premium segment of the London Stock Exchange. The company is a constituent of the FTSE All Share index and has a market capitalisation of approximately £225m.
Full year results to 31 December 2023 were published on 6 March 2024 and we were delighted to welcome new CEO Adolfo Hernandez and Deputy Director of Investor Relations Stephanie Little, to present the FY23 results and talk about the company’s prospects. A recording of the webinar is available here.
Adolfo joined earlier this year and has now been in the post for 9 weeks. He was previously at AWS as VP of Global Telecoms. He has 30 years’ experience in software and services at companies including IBM, Alcatel and Lucent and believes he has the skills and capabilities to unlock the huge value opportunity at Capita. Indeed, Adolfo describes his no.1 mission to unlock value for society, for customers and for employees and to get this to translate into stronger financial performance. The starting point, he admitted, is challenging but he is excited to take this on.
Looking at the financial performance for FY2023 the results delivered were in line with the trading update given in December 2023 but the company admitted that this performance was disappointing. They also commented that these results are “the results” and it’s not been a question of “kitchen sinking” these figures to make the recovery look better. In terms of top level highlights the £500m portfolio disposal programme was completed in January and the debt facility was extended until 2026. The triennial pension scheme valuation was agreed with the trustees which will mean that no further deficit contributions will be made from 2025 onwards. The first wave of £60m of cost savings is on track to be achieved in Q1 2024 and a further £100m of cost savings will be achieved by mid-2025.
The financial performance of the company reported in 2023 showed a modest improvement on the performance in 2022. On an adjusted basis Revenue rose 1.3% to £2642.1m, operating profit rose 36.5% to £106.5m, PBT rose 13.5% to £56.5m and EPS fell 34.6% to 1.7p. However, free cash flow deteriorated to an outflow of £115.5m, net debt (pre IFRS16) increased to £545.5m and net financial debt grew by 114.5% to £182.1m.
Within the divisions, Capita Public Services saw flat revenues and a small decrease in margin to 6.1%. EBITDA grew 1.1% to £133.3m, operating cash flow grew 4.7% to £107.1m and cash conversion improved to 80.3%. Capita Experience increased revenues by 2.5% and operating profits by 42.6% and margins rose to 4.3%. EBITDA rose 1.3% to £111.3m, operating cash flow fell 9.4% to 32.7m and cash conversion fell to 29.4%.
Further explanation was given to the movements in free cash flow as a large proportion of these cash outflows will not be repeating and will allow the company to reach positive free cash flow in 2025. The largest one off component is the £30m pension deficit payment. A further £20.1m was spent on the cyber incident, £4.9m of furlough payments were repaid and implementation of the cost reduction programme accounted for a £6.1m outflow. The full benefits of the cost reduction programme will be seen in 2025 which will enable the company to reach positive free cash flow.
Commenting on the debt, which was a little worse than expected, it was noted that proceeds from the final disposal were not received until 2024 when a number of analysts were expecting these to be received in 2023. On the topic of dividends, the company needs to be in a position of being able to afford them as the first step as this will provide the company with options and a decision to make on how to deploy capital. The question will be addressed when they are at this point but the CEO reiterated he was keen to be able to pay dividends.
The guidance for 2024 was laid out clearly. Revenues are expected to be broadly similar to 2023 with operating margins improving slightly due to the benefits of the cost reduction program. The Experience division is expected to show modest revenue reduction and the Public Service division is expected to show modest revenue growth. Cash conversion is expected to improve and fall within a 60-70% range while free cash flow is expected to be an outflow of £70-£90m after spending £50m on the impact of the efficiency programmes. Net debt will rise again driven by the free cash flow movement. Revenue and margin performance are both likely to be better in the second half of the year.
When looking forward at what needs to be done there is a recognition that these results just delivered are a long way short of what the company could deliver. A lot of good work is being carried out across the business and a lot of value is being created but this is not being translated into the numbers. Management have taken on board the clear requirement to dramatically turn around the financial performance of the business.
In terms of initial observations from the CEO, there was a good understanding that customer relations were extremely strong and a lot of value was being created for society and customers. Once arrived though, the sense of value creation in multiple areas and strength of customer relationships were even more apparent. Initial conversations with senior personnel across government departments and with their biggest clients indicate that Capita is held in high regard. In interactions with frontline colleagues across different areas the quality of the staff has come through and their determination to make Capita a success equally impressive. However, it was also clear that the financial performance was disappointing and whilst improving it was not improving at the required pace and quantum.
There are three improvements that can be made relatively quickly which should improve financial performance. The first is the process of simplifying tasks and improving the why, how, who and where tasks are done and delivered. The second is developing standardising and repeatable business processes. The last one is being better at helping their customers move along the digital transformation journey for the tasks that they already manage. Combined these measures should make Capita a more agile, competitive firm, offering a higher quality service at a higher gross margin and better financial performance.
A capital markets day is planned for 13 June 2024 when more details will be shared on the following topics: cutting costs and spending less; digitalising the offer; leveraging technology partnerships like AWS and Microsoft; improving the quality and precision of delivery and adopting a culture which is more accountable with greater empowerment. Guidance on long term revenue growth and margin opportunity will be shared too.
In his closing remarks Adolfo stated again that the financial performance at Capita is not where he would like it to be but the management team are committed to improving this performance. There is no magic wand, but there is a clear, low risk plan to achieve this. All eyes will be on the capital markets day in June to provide more detail on this. There is a lot of work to be done and it was encouraging to see the new CEO honestly laying out the challenges ahead and his commitment to address them.
A recording of the webinar can be found on the Yellowstone Advisory YouTube channel or by clicking here.
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