Shares digital

Capita (CPI) – 680.5p, stop loss 544p

SHARES SUMMARY

Not cheap but it has a tremendous long-term earnings growth record, which is so good it cannot be down to luck but rather good execution and shrewd strategy.

Business:

Acquisitive business process outsourcing specialist focused on the UK and Ireland.

Vital stats:

Market value: £4,136 million

Historic PE: 24.5

Prospective PE 2008: 22.1

Prospective PE 2009: 18.2

Sector PE (next 12 months): 16.8

1-month relative strength: 6.5%

1-year relative strength: 10.7%

Yield 2008: 2.1%

NMS: 12,500

Spread: 0.075%

If one of America’s five largest investment banks, a household name such as Bear Stearns (BSC:NYSE), can have a share price of $60 one week and be sold for $10 the next, at a price one-eighth of its official book value per share, then it still seems sensible to be looking for stocks with a proven track record of dependable and solid operational performance. Very few stocks are capable of generating the premium growth, cashflow and returns on capital required to sustain long-term outperformance of the broader market. Professional support services firm Capita has generated 25% trend EPS growth over the past ten years and therefore fits the bill admirably.

Capita is a UK business process outsourcing and professional services company. The £4.1 billion cap delivers delivers back office administration and front office customer contact services to private and public sector organisations across the UK and Ireland, enabling customers to improve their services while maintaining a firm grip on costs. A long-term trend toward outsourcing, particularly at an increasingly cash-strapped government, should cement Capita’s growth prospects.

The group’s core skills range from processing business travel bookings, operating call centres and document management to payroll services, health consultancy, IT services and the administration behind 15 million life, savings and pensions policies.

Losing the contract for running London’s congestion charging scheme from 2009 onwards to IBM knocked the shares hard last October. But contracts such as a £722 million, ten-year deal to handle pensions and endowment policies for Prudential (PRU) mean Capita bagged fresh deals worth nearly £2 billion last year, and the long-term nature of the firm’s contracts means earnings visibility is good and dependence upon any one customer is low.

Last month’s £28 million acquisition of Computerland (CPU) was Capita’s 13th acquisition in barely 12 months and took spending on deals to £143 million. Chief executive Paul Pindar, who took the reins in summer 1999, has built a team with great experience in integrating this type of bolt-on deal, which should swiftly contribute to the overall group’s earnings momentum.

The biggest bear point always put alongside Capita is that the stock never looks cheap. Granted, a prospective PE for 2008 of 20.6 does not look like a giveaway compared with a UK market allegedly on around 11. Yet Capita’s bulging backlog means forecasts here should be relatively safe. In contrast, a huge slug of the All Share’s earnings comes from banks and insurers, where forecasts are anything but clear-cut, and miners and oil stocks, where record commodity prices are producing low, and possibly ‘peak’ earnings multiples. The valuation disparity may not therefore be as great as it first seems and, as

Bear Stearns stockholders can tell you to their cost, a little certainty will go a long way in these volatile markets.

by: Russ Mould