Capita's time could come again

Research pays off for Renishaw; MFI has room to improve further
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The love affair between the stock market and Capita Group - the operator of London's congestion charge - has been through a bad patch of late, but there was a lot of kissing and making up yesterday. Capita's shares rose a steamy 9 per cent after its interim results hit all the market's erogenous zones.

The giant capital expenditure bills of the past few years will not recur. Ooo. Cash from the operating business is up 49 per cent. Aah. Bids have gone in for a record £2.8bn of new contracts. That's nice.

So what are the prospects for a new love-in? Rod Aldridge, executive chairman, says he was never unfaithful to the group's growth strategy. The business he founded in the Eighties has grown by taking over administrative functions from local and central government and, latterly, private businesses. Capita is the group that collects your TV licence, pays teachers' pensions, perhaps sends out your council tax bill, looks after criminal records and may well deal with your insurance claim.

It was the stock market that changed, nagging on about cash flows, arguing Mr Aldridge was spending too much to set up the IT behind the Congestion Charge scheme (which made £6m profit for Capita in the first half of 2003). Relations got so poor that Capita was thrown out of the FTSE 100 in March.

Both sides agree that the growth rates of the past may be unsustainable now Capita is so large, but the stock market seemed to realise yesterday that the profit improvement still on offer will be better than the average quoted company for many years to come.

The business opportunities continue to be large. The Government has said it will allow local authorities to keep the proceeds of congestion charging, making it likely that the Capita scheme developed for London could be rolled out in other areas. Mr Aldridge is talking up the possibility of expanding Capita's presence in the reforming National Health Service, where it already provides consultancy, property and recruitment services. And the general trend for outsourcing administrative functions looks set to continue.

Risks to Capita's good name still abound. The group took a knock last summer as a result of the fiasco at its Criminal Records Bureau, and it lost one of its oldest local government contracts, in Norfolk, this month. But counter to this is the acclaimed launch of the Congestion Charge and Capita's promise not to seek high-risk growth overseas.

The savage derating of the shares of the last year means that 20 per cent annual earnings growth for several years is available on a price-earnings multiple of 19. Mr Aldridge could once again become the market's Mr Right.

Research pays off for Renishaw

Renishaw, the manufacturer of hi-tech industrial measuring equipment, is proving its mettle in an economic slump. The group produces equipment that measures distances to within one-millionth of an inch - used in the making of cars, artificial hips and teeth moulds and for restoring Old Masters.

Annual sales were up 6 per cent and pre-tax profits were up 11 per cent. Not bad, considering the doom and gloom its industrial customers have been experiencing. Although it is heavily exposed to US, German and Japanese manufacturing industries - which have slumped - it is pulling in sales elsewhere. Turnover in the Far East rose 17 per cent as global manufacturers shifted production to low-cost countries.

The major downsides are that the group has high fixed costs and the shares are 53 per cent owned by its founders, making them illiquid and poorly researched by the City. Renishaw spends a lot on research and development, which pays off in terms of growth prospects but constrains the dividend.

Renishaw shares have recovered well in the past 18 months. At 498.5p, they are trading at 21 times forecast earnings and have a 3 per cent dividend yield. Investors searching this sector will find high-yielding bargains elsewhere, but existing shareholders should hold on.

MFI has room to improve further

MFI Furniture has been one of the retail sector's best performers of late, enjoying a surging run that has seen the shares double in the last six months and rise three fold in the past three years.

The bedrock of recent growth has been a push into "all rooms in the house" taking MFI into bathrooms and living room sofas as well as bedrooms and kitchens. A refurbishment programme, which is seeing some of MFI's 191 UK stores being given a stylish Conran makeover, is also sprinkling fairy dust on the figures.

The question is whether the company can keep it up. First-half profits were up to £59m from £46m last year and like-for-like sales in the UK stores were up 5.1 per cent on the same period in 2002. There is no sign of a slowdown since the half-year.

The good news is that only two-thirds of the estate has been overhauled meaning there is still some upside to go for. Operating margins in the 100 stores refitted so far have jumped from 5 per cent to 9 per cent, showing there is a profit as well as a sales gain. Those that have received the full treatment are showing sales uplift of 25 per cent. Partial refits have performed less well and a new way of doing these is being tested, with a decision due soon.

Meanwhile MFI's Howden Joinery subsidiary is enjoying sales growth that is so strong it is almost rude. Like-for-like sales are up 27 per cent as the format becomes increasingly popular with smaller builders. The 280 branches are to be expanded to 300 by the end of the year. Howden's other growth opportunity is the US where MFI has opened 15 trial stores. The trial will continue for another six months but MFI believes there could be scope for 40 or 50 more.

Assuming full-year profits of £100m, the shares trade on a forward price-earnings multiple of 15. They dipped 7p to 173p yesterday on profit taking and long-standing investors might like to follow suit. More recent converts should hold on.

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