Why Capita surge may not last

Capita is top of the blue-chips on Tuesday. Its share price is up as much as 6% as the outsourcing giant struck a much more positive tone in a first-quarter statement prepared for today's AGM. Yes, there are certainly positives here, but there's also enough to feed the bears, and it's unclear whether it's sufficient to make this breakout stick.

We're told the company, responsible for large swathes of NHS admin, the London congestion charge and military recruitment, said it has made a "solid start to 2016". It has £458 million of major contracts in the bag, and is confident of growing organic revenue by "at least 4%" this year. That's the same as in 2015 and unchanged from the target included in February's full-year results.

It adds: "With divisional growth building on the success of last year, our steady progress in securing major new and extended contracts, further anticipated conversion of our bid pipeline and a good pipeline of potential small- to medium-sized acquisitions, we are on track to meet consensus expectations in 2016."

Clearly, there's appetite for the shares following a 26% plunge from last July's record high at 1,336p. On Friday, they were being sold for just 982p, the cheapest in over two years. In February, they'd collapsed below £10 for the first time since February 2014 after admitting reported profits halved and the bid pipeline had shrunk from £5.1 billion to £4.7 billion.

But this update is light on numbers, argues Panmure Gordon analyst and confirmed seller, Michael Donnelly.

Contract wins so far this year are less than half the level at this point last year. Then, Capita said the bid pipeline "remains buoyant in both the private and public sector". Today, it only "remains active", and chiefs admit some of these contracts are "taking a little longer than expected to come through".

Normally acquisitive - a splurge over the past decade swelled profit, but also net debt to £1.8 billion - the company has spent just £23 million on acquisitions so far this year. That's just 9% of Donnelly's target spend for the full-year.

At 1,079p, Capita trades on 14.4 times Panmure's earnings per share estimate of 74.8p for 2016, downgraded from 75.9p on Tuesday. It still trades on 14 times earnings for 2017 following a 2% downgrade to forecasts.

Historically, certainly for the past couple of years, Capita has traded on a multiple of around 17 or more. This is something acknowledged by Donnelly, but he believes that if capital expenditure rises above 5% of sales, "free cash flow growth could fall to zero in 2017, and possibly beyond".

"Even after the recent falls (the shares are down 22% over the past six months) we continue to believe that such lacklustre cash generation represents very poor value for investors," adds Donnelly, who continues to rate the shares a 'sell' with 900p price target.

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