Sell out of Capita's weak growth prospects

In September, management warned that referendum-related delays to client decision-making meant that organic revenue growth for 2016 would be around 1 per cent, down from previous guidance of 4 per cent, and underlying pre-tax profit was revised down to between £535m and £555m from £614m. However, in December these expectations were once again chopped back to underlying pre-tax profit of about £515m.

Profitability has been hit by delays, including planned work to install a new IT system for Transport for London (TfL). The IT enterprise services division has also experienced a slowdown in new work, while its workplace services business has suffered from weak demand for specialist recruitment.

After judging some parts of its asset services business - which has also experienced a slowdown in contracts - to be no longer core to the future strategy, Capita has decided to sell the majority of this operation. These businesses are expected to contribute £60m in operating profit during 2016. The sale is set to complete by the second half of this year.

Capita is also in the process of reducing its divisions to 11 to six. This is expected to cost around £50m. Big "non-underlying" costs at Capita are nothing new. A large amount of acquisitions means the outsourcer's divisional structure has been subject to several changes during the past two years, which have resulted in reorganisation costs, impairment charges and losses on disposals. Indeed, the high level of non-underlying charges compared with reported underlying profit gives grounds to question the quality of the group's earnings - see chart.

 Acquisitions have been an important part of Capita's growth strategy during recent years and make performance from year to year somewhat harder to compare, especially since organic growth has been inconsistent during the past 10 years. When organic growth has been weak, bolt-on purchases have helped maintain revenue growth. However, management now plans to take its foot off the acquisition pedal over the next two years.

That looks timely, as falling profits mean net debt to cash profit is set rise beyond the group's target range to 2.9 times at the year-end from 2.5 times at the end of June. The sale of asset services, should bring this back to the lower end of its target range of between 2 and 2.5 times. There have been rumours that private equity groups bidding for its asset services division may make a bid for the whole group. However, the high level of debt makes Capita a less likely buyout target.