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 £500m.
Half year results to 30th June 2022 were published on 5th August and we were delighted to have Stuart Morgan, Director of Investor Relations, present and talk about the company’s prospects. A recording of the webinar is available here.
Stuart opened with a summary of the first half performance and the key message that they are on track to deliver on their 2022 commitments. The highlights of H1 were: further revenue growth after the first revenue growth for 6 years in 2022; strong operational performance (a key component of the transformation); an improvement in net promoter scores which has aided recruitment and retention of people; profit growth; delivery of positive free cash flow and a significant reduction in net debt.
Moving into more detail of the financial results the revenue number increased slightly to £1,480.1m as contract losses from 2021 started to expire and there was progress growing the business. Profits grew to £52.2m through a combination of increased revenues and some efficiency benefits and the company delivered positive free cash flow of £12.7m. Net debt on a pre IFRS basis reduced by £142.1m to £289.3m and on a post IFRS basis reduced by £170m.
Looking in more detail at the movements in revenue there were some covid related contract losses and reduction in scope of work but these were more than offset by the £55m of contract wins. Notable contributions were the Royall Navy, Job Entry scheme in Scotland and the Northern Ireland Educational Authority.
At the divisional level the Capita Public Services division continues to grow both revenues and margins. The Experiences division fell slightly but the performance was a big improvement on the 9% revenue decline in the prior year. The profit decline in Experiences reflects that revenue decline. The portfolio division had a good half mainly as a result of recovering from the impacts of Covid. The plc benefit was significant as restructuring costs have substantially reduced as the restructuring comes to an end and these costs are now taken above the line.
The reported profit before tax reflects lower profits on business disposals and a goodwill impairment charge. Management are particularly pleased that the company generated positive free cash flow of £12.7m and they are determined to improve on this. Operating cash flow conversion improved to 64% and they believe this can go further, there was a significant decline in the pensions contribution and further business sales all contributed to a £170m reduction in net debt.
The balance sheet is in a significantly better position too. The RCF of £358.1m is undrawn, £82m of private placement notes were repaid in the first half and a further £140m will be repaid in the second half leaving the company with a much reduced leverage position.
In terms of the financial outlook for the rest of the year the company sees revenue growth trends improving in each of the divisions, EBITDA margin will fall slightly this year, positive free cash flow is targeted for the full year and net debt will continue to decrease. The size of the overall net debt position at the year end will depend on the timing of disposal proceeds. Whilst the sales process for all remaining businesses to be sold will have launched in the second half some of the proceeds may not be received until 2023. However, by the time of the half year results Capita expect net debt to be non-existent or negligible.
ESG remains at the heart of what they do and Stuart referenced 4 key components: there is now a board oversight committee, the staff Net Promoter score has improved significantly, they have maintained the real living wage commitment and net zero strategy is being implemented at the divisional level.
Diving into the revenue performance in more detail there has been a pleasing performance in work won which grew by 4% to £1.6bn (excluding the lumpy Royal Navy contract). The renewals rate is a very respectable 95% and the win rate on new business is 42%. With the pipeline of new business opportunities standing at £14.4bn Capita is well placed for further revenue growth. This pipeline combines renewals, new scope of work and new clients. Notable wins include TV Licencing, Scottish Power, Allianz Partners and there are good opportunities in the second half from o2/Virgin, TfL and the Student Loan Company.
The new operating model has also led to a focus on winning business from clients where Capita has deep expertise. The approach is to use consulting skills to demonstrate capabilities and credibility to drive business by providing client solutions using a range of Capita products. The sales team is also working to drive incremental sales from existing accounts and more smaller deals.
Capita’s Digital expertise has also played a role in winning new business. This includes things like automation, cloud migration, AI and data analytics. In the Public division they are leveraging the technology stack using global suppliers. The Experience division already has a competitive platform and they are working to deliver this more effectively. An example of this in the Public Services Division is working with HMRC where they have become their automation partner. In the Experience division Capita has helped a consumer electronics company deliver on a number of operational KPI’s and they are doing this with 98% of the staff all working from home. This WFH approach is hoped to be rolled out for other clients going forward.
Improving margins remains a key target for the company and whilst margins are expected to decline slightly in the current year the company sees significant margin improvement going forward. This margin improvement will come from the successful execution of major contracts, a disciplined approach to contract bidding, a focus on continuous improvement, more use of standardised tools, reducing the property footprint and cutting the central overhead. Reducing the property footprint both saves costs and reduces the overall net debt. Property footprint has been cut by 25% over the last 2 years, there were 18 disposals in the first half and a further 9 buildings will be vacated in the second half. Overall property costs are expected to decline by a further 20% by the end of 2023.
A slide addressing inflation indicated the company doesn’t expect a material impact in 2022 mainly due to the timing of inflation increases. Government contracts are rebased in April based on H2 2021 indexation. Capita is confident they can manage the inflation risk as 2/3 of their contracts have indexation built in, a lot of Capita business is transactional and here the rate card is updated regularly and they are involved in regular discussions with clients about how services/staff retention can be improved with price increases.
Looking specifically at how the company has manged a tight labour market they have made efforts to make Capita a more attractive place to work through the use of WFH flexibility where appropriate and this has delivered significant improvements in their staff net promoter score. The company has staff to deliver the existing contracts but if anything needs more people to help grow the top line.
There was a very encouraging update on the disposals in the portfolio division and the process for selling all businesses is expected to be launched by the end of 2022. Some of these disposals will close in the current year and some will come through in 2023. When this completes the company will be left with no or negligible financial debt. As part of the process, they have agreed with the Pension trustees to pay early some of the £45m annual pension payments scheduled for 2024-2026. At the next triennial review these pensions could be in surplus and no further outer year payments will be required further increasing the free cash flow.
In summary, the first half performance was in line with expectations. The new operating model is embedded in Capita which places the company in a strong position to grow the business from a pipeline of better-quality contracts. There are further opportunities to take costs out which will flow through into margins and with the disposal of the remaining businesses in the portfolio division the company will be substantially debt free. In response to a question about a return to the dividend list, Stuart commented that when core Capita is generating positive free cash flow then returns to shareholders will be considered. A possibility for 2023 but more likely for 2024.
All in all, an encouraging update delivered in a more confident tone.
A recording of the webinar can be found on the Yellowstone Advisory YouTube channel or by clicking here.
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