Capita punished for brutal 'kitchen sink' job

As "kitchen sinking" goes, today's profits downgrade, rights issue and dividend suspension from new Capita boss Jonathan Lewis will be viewed as one of the biggest of recent corporate times.

Capita shares tanked by a spectacular 45% to their lowest level since 2003, leaving a host of fund managers and City analysts with some explaining to do. In fact, the Financial Times reported today that only two out of 16 analysts polled by Bloomberg had a 'sell' rating on Capita before this morning.

A fortnight ago, Neil Woodford's Income Focus fund revealed that it had boosted its Capita exposure after the stock fell 12% in December. It also wrote about the potential for significant value creation in the future as the group returns to the "high quality, successful and well-run business that it used to be".

The Woodford note conceded that a dividend cut could not be ruled out, with a 7% dividend yield suggesting that some investors already feared this outcome.

Framed by the recent dramatic events at Carillion, perhaps the dividend suspension and decision to protect the balance sheet isn't such a surprise.

As Lewis pointed out today, the recent cash management performance of the business has been troubling, with outflows expected in 2018 totalling around £500 million. Until this trend is reversed, there will be no dividend.

Lewis said: "Capita is too complex, it is driven by a short-term focus and lacks operational discipline and financial flexibility."

The outlook on current trading is also concerning, with pre-tax profits now likely to be between £270 million and £300 million in 2018, compared with estimates for around £380 million. Capita admits it is paying the price for placing too much emphasis on acquisitions to drive growth, rather than responding to new customer demands.

In a significant move earlier this month, Prudential said the administration of its life and pensions business would be transferring to a new firm in the summer, resulting in the loss of £80 million in revenues for Capita. The company warned as recently as December that 2018 was shaping up to be a tough year, fuelling worries about the future of the dividend.

Lewis now admits that reducing costs, selling non-core businesses and improving operational efficiency will not be enough on their own to turnaround the business, which is why he has taken the "significant decision" to suspend the 31.7p a share dividend and seek equity.

He has form in this area, having been at the helm of Amec Foster Wheeler when it announced plans to suspend dividend payments and ask for £500 million through a rights issue. The fundraising never happened because the company was taken over by Wood Group.

Other outsourcers have already gone down the same path, with newly-arrived Serco boss Rupert Soames raising £500 million from shareholders when the business was in dire straits in 2014. At an estimated £700 million, the cash call planned by Capita for later this year will surpass that.

Whether this will be enough to put Capita back on the road to recovery remains to be seen. Shares are now 84% lower than their peak seen in 2015.

However, Peel Hunt analyst Christopher Bamberry believes the strategy unveiled by Lewis makes sense. He said: "The focusing of the group on a smaller number of better competitively positioned business, with a strengthened balance sheet, allowing appropriate levels of investment, are welcome steps in the right direction."

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