Capita: Why traders are piling into this Woodford stock

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Capita: Why traders are piling into this Woodford stock

After an incredible reaction to Capita's (CPI) latest trading update, we could be seeing the start of "a big turnaround story" for one of the most troubled stocks in the FTSE All-Share index (ASX) in recent years.

Capita had a terrible 2016, losing over half its value following a couple of profit warnings, the first of which in September - a maiden warning for the firm - led to a spectacular crash that eventually wiped out a quarter of its value in one day.

Its share price eventually bottomed out in December at 431p, and shortly after we saw signs of a nascent recovery. Friday's general election spooked the market again, and Capita shares fell 5% to a three-month low of 515p.

However, a day after rival Mitie (MTO) rocketed over 16% on cost-cutting measures and a better-than-expected outlook, Capita surged as much as 15% Tuesday to an eight-month high.

We're told the firm is making good progress with its restructuring plans, including the start of its disposals programme - it has already sold its specialist recruitment businesses and the sale of Capita Asset Services should complete in the second half of 2017.

Elsewhere, Capita has a "shortlist of strong candidates" for the soon-to-be vacant chief executive position. Current boss Andy Parker, who took over in 2014 with the share price at over a tenner, announced back in March he would step down, just a day after the company fell out of the FTSE 100 index (UKX).

On fundamentals, the firm says profit in the first half of 2017 will be "no lower" than the second half of 2016. Profitability will improve in the second half as it becomes "a simpler business, better positioned to exploit our fundamental strengths and generate renewed sales performance".

This will support "a clear pathway to return to sustainable profitable growth in 2018 and beyond", management explains. This year has started well and trading is in line with expectations.

Future performance will be helped by some major contract wins - £318 million so far this year, including extensions to deals with the RSPCA and Royal London, as well as a couple with the government including extending its Personal Independence Payments contract.

It also confirmed it's in talks with British Airways about a potential partnership to support its global customer contact operations.

Share price performance was strong Tuesday, hitting 634.5p for a 19% gain since Friday's low. It's a win for our technical analyst Alistair Strang, as he tipped Capita to recovery to 622p back in January, with the stock at £5.

There are potential risks on the horizon, however. A broker note from Barclays Monday spelled them out in stark terms - should the Conservative party fail in its attempts to cobble together a minority government but Labour succeed, public sector-focused support services firms could be the biggest losers.

Reasons for this include the potential for existing contracts to be negotiated with a greater proportion of work insourced, lower contract values upon renewal, rising cost pressures from an increased national minimum wage and higher rates of corporation tax.

While Jeremy Corbyn's most radical policies would likely be reined in due to it being a minority government, Capita generates around 50% of revenues from the public sector so is at risk of a negative share price reaction should this play out.

That said, in the event of a Conservative administration, little would change in the short-term, though "political instability/uncertainty would likely delay decision-making, reducing growth opportunities".

But Capita has plenty of fans in the City - the most high-profile of which being Neil Woodford. The fund manager holds Capita in both his Equity Income and Income Focus portfolios and last year it seemed the further the company fell, the more Woodford bought shares.

He repeatedly pointed to a "safe" dividend yield of above 5% as a reason for adding to his holding "at a very depressed level" after its first profit warning in September.

Reflecting on a "disappointing" year for Woodford Equity Income, the former Invesco Perpetual star admitted owning the stock was "a mistake" but has stuck with it, adding it to his newest fund, the high-yielding Woodford Income Focus.

And last week, previewing today's update, broker UBS described Capita as one of the sector's "biggest turnaround candidates". There are a number of catalysts on the horizon, analyst Rory McKenzie reckons, though stabilisation is the key for the time being.

Capita now trades above McKenzie's 580p price target, but still on less than 12 times forward earnings - a big discount to the market - and yields 5%.

The upside case to UBS's view is 790p - just 3p shy of Alistair Strang's secondary target, mentioned should Capita top 622p.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.