Capita flourishes on outsourcing

The Investment Column

Capita has come a long way since Rod Aldridge paid the Chartered Institute of Public Finance & Accountancy pounds 330,000 for the business in 1987. It was making profits of pounds 57,000 then, a fraction of the pounds 11.3m pencilled in for the full year to December.

Yesterday's first half figures, showing pre-tax profits up 14 per cent to pounds 4.6m, were struck from turnover 15 per cent higher at pounds 50.1m. They confirmed that the market for what the jargon terms outsourcing - paying someone else to do a peripheral function so you can get on with your core business - is flourishing.

Capita, which has grown from its roots in information technology, now extends to a wide range of services including running the written part of the new driving test, running all the non-clinical side of an NHS trust hospital, and even administering the teachers' pension scheme.

The company's success partly reflects the underlying growth in the market, which some estimates believe could be increasing at a compound rate of 24 per cent a year. But it is also testimony to Capita's ability to judge contracts well, to price them correctly to win a tender and then to cut costs quickly enough to create a decent margin.

That is no mean feat, especially as the sort of contracts Capita now wins are getting increasingly long and complex. Margins on these large deals are often low in the opening months, rise as operational efficiences are introduced and improve still further as bolt-on contracts are pushed through. In the Isle of Wight, for example, a second NHS trust contract will use much of the same infrastructure as the first one that proved Capita's worth but involved heavy start-up costs.

The good news for Capita shareholders is that the company is operating at record activity levels, with contracts worth pounds 254m signed in the last 12 months. Of that total, contracts to a value of pounds 174m do not start until the second half-year and there is no evidence at all of the prospect of a Labour government stemming the flow of this peculiarly Tory invention.

The bad news, however, is that the good news is well and truly in the price. As ever with fast growing companies, the 20 per cent-plus growth rates possible in the early years become increasingly difficult to maintain as the years roll by. Analysts are forecasting 17 per cent earnings growth this year, followed by 16 per cent in 1997.

That is impressive enough by most standards, but compared with a prospective price/earnings ratio of 25 this year it is perhaps not enough to sustain the share price. The shares have fallen from a high this summer of 380p and still look vulnerable.