US Edition Capita
£10.62+12p
Questor says SELL
OUTSOURCING giant Capita yesterday signed a major contract to link up all the public sector computers in Scotland.
The deal brings greater confidence about revenue growth at the FTSE 100 business, but it could take time to implement and Questor remains concerned about the falling profit margins with national elections looming on the horizon.
The Scottish Wide Area Network (SWAN) contract will see Capita ensure that hospitals, schools, GP surgeries and council offices are all linked to the same computer network. The scheme is worth £325m for a period of nine years, or £36m in revenue a year.
However, the initial contract size will be smaller. Capita will be linking up 4,600 sites across public sector organisations including NHS Scotland, Education Scotland, and six local authorities. These early adopters of the technology will generate revenues of £110m for seven years, or £15.7m a year, less than half the full contract rate.
“This is an important contract win for Capita, placing us at the heart of public service delivery in Scotland and providing us with a platform to offer additional services and build our business here,” said Paul Pindar, chief executive, who will step down from leading the company on March 1.
Capita has now secured two out of the three biggest contracts the company said it was bidding for at the end of last year. The outsourcer regained the London congestion charge contract in January, valued at £145m for five years, after losing it to IBM four years ago. The company also recently won the prisoner electronic tagging contract after rivals Serco and G4S were stripped of the work following their referral to the Serious Fraud Office following allegations of overcharging.
While strong revenue growth at the company looks set to continue, profit margin concerns persist. Underpinned by new contract wins, analysts are expecting the company to achieve revenue growth of about 8pc in the year ahead, well above Capita’s own target of 5pc for 2014.
The shares have warranted a premium to peers because of the revenue growth and superior profit margins the company has delivered. For the past three years the group’s 14pc-plus margin has been well ahead of the rest of the outsourcing sector, which typically generates margins in the mid to high single digits. Serco has an operating margin of 6.4pc, while G4S sits at 5.5pc.
Capita’s profit margins are now under pressure. In 2011 Capita had a 14.59pc unadjusted underlying operating margin; in 2012 this slipped to 14.07pc and for the foreseeable future the company now guides to between 12.5pc and 13.5pc.
Mr Pindar has been confident on that margin guidance and believes the figure should remain comfortably within that range in 2014. He added that profit margins will be helped by the sale of the loss-making insurance administration business that had revenues of £47m and made a £15m loss during 2013.
A sliding profit margin is an indicator of just how competitive the environment for winning contracts is becoming. The situation could get worse as outsourcers fight to win contracts ahead of a hiatus that surrounds spending decisions around a general election.
Capita shares are at record highs trading on 17 times forecast earnings, falling to 15 times next year. The company has to deliver revenue growth of 10pc in the year ahead and 7pc next year, combined with pre-tax profit growth of 12pc and 9pc respectively. Capita is a successful and growing company but Questor thinks those targets look too ambitious. The shares have risen 8pc since Questor last recommended taking profits (Sell, 977p, November 19), but on a prudent outlook that stance is maintained. Sell.