Should you pile into Capita plc, down 40% today?

Outsourcing group Capita‘s (LSE: CPI) precipitous share price plunge will leave many investors nursing a bad case of déjà vu. Many are still licking their wounds after snatching at another government contractor Carillion (LSE: CLLN), last year’s falling knife, this year’s political scandal. Can Capita’s story have a happier ending?

Lewis gun

Capita’s stock is falling at the fastest rate in 24 years after new chief executive Jonathan Lewis announced his plans for a rights issue and suspended the company’s dividend payments. Lewis took the reins on 1 December and today announced the group is commencing a “multi-year transformation programme and is committed to delivering a strategic review” during 2018.

The dividend is suspended until the company is generating sustainable free cash flow, Lewis said. The group is also planning a rights issue for up to £700m this year and will pursue a non-core disposal programme over the next two years. The aim is to strengthen the balance sheet, with a target leverage ratio of one to two times net debt-to-EBITDA.

Poor discipline

Despite this, Lewis remains positive, claiming that the “building blocks exist to create a great business.” 2018 underlying pre-tax profits, before significant new contracts and restructuring costs, have been adjusted downwards to between £270m and £300m, some 30% below the forecast £389m for 2017.

Lewis has rightly seen that the group is too widely spread across multiple markets and services, making it more challenging to maintain a competitive advantage. “Today, Capita is too complex, it is driven by a short-term focus and lacks operational discipline and financial flexibility,” he concluded.

Down, down, down

As I wrote last July when advising investors to stand clear of Carillion, a share price smash-up like today’s does not happen overnight. Capita was the worst performing stock on the FTSE 100 in 2016, falling more than 60% after issuing a profit warning, which it blamed on Brexit scaring away business customers. Its share price has plunged from around £11 to £2 in just two years and it dropped out of the FTSE 100 last March. My Foolish friend Royston Wild wisely suggested selling this stock after it crashed 10% last September

Lewis is rightly grasping the nettle and although he has shocked the market, it does position him as a man of purpose, a man with a plan. A major overhaul is required, and he is right to unleash an extensive restructuring programme sooner rather than later.

Political threat

However, there is political risk as well. Ministers will be all over this one after failing to act early enough with Carillion. Brexit uncertainty continues to persist. Prospective clients and suppliers may be wary of signing new contracts. This is a sectoral malaise: support services groups Interserve, Mitie and Serco are down 51%, 31% and 18% respectively over the past six months.

Today is a welcome move. Lewis has seized the narrative, and strengthening the balance sheet and focusing on the group’s winning businesses is also wise. However, there is a long way to go, plus the possibility of further shocks. I will not be piling in. You might be made of sterner stuff.

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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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