Investment Column: Capita faces outsourcing uncertainty
Betfair; Domino Printing
Wednesday 15 December 2010
Our view: Hold
Share price: 680p (+1P)
The idea of an outsourcing boom has taken a few nasty knocks in recent months. As we highlighted in recent columns, the thought that companies such as Capita would gain as the Treasury took an axe to spending and went searching for outsourcing-led efficiency gains has lost a lot of its sheen: witness rival Serco's unsuccessful attempt to secure rebates from its suppliers as the cutbacks started to bite. Others have simply gone bust.
The sorry saga highlighted concerns that that while the Government squeeze might drive higher volumes the way of outsourcers, the business it sends there way might not be very profitable. The outsourcing story was called into question once more when Capita issued its interim management statement last month. Its shares fell to their lowest level in more than a year after it warned that second-half sales would be hit by Government cuts.
At the time, Shore Capital analysts said that while management was right about the scope for "material growth" from public-sector outsourcing, the fruits of the efficiency drive might take longer than expected to ripen. Indeed, they went on to say that Capita's bosses may end up being disappointed by the "slowness of this process". But there is still potential in that long-term picture, arguing against a sell stance. Moreover, at 17 times forecast earnings for 2011 and with a yield of 3 per cent, according to Panmure Gordon, we do not think Capita is expensive.
We also liked the look of the iSoft Business Solutions acquisition, which was announced yesterday, and which will help to boost Capita's standing in the expanding and lucrative healthcare market.
The short term is uncertain, particularly in the context of the high hopes in the run-up to, and in the weeks and months shortly after, the general election. But hold, and keep an eye on developments.
Our view: Avoid
Share price: 990p (-191p)
After racing to the front of the pack with its autumn flotation, Betfair was all but pulled up lame yesterday. The betting exchange's shares took a hammering as its first set of a results as a quoted company missed City forecasts.A World Cup-led summer boom has been replaced by lacklustre trading more recently, which won't be helped by the string of horse-racing meetings cancelled because of the cold.
Across the group, profit before tax for the first half fell by 19 per cent to £7.45m (although that was hit by one-off expenses related to the flotation). Overall revenues were 27 per cent higher at £213.3m, but underlying revenues – excluding "high rollers" who pay very high commissions to the exchange – rose by just 12 per cent.
That might look OK on the face of it, but Evolution Securities highlighted concerns about the decline in horse-racing revenues in the second quarter and it doesn't look at all good when you consider the enormous premium the shares trade at compared with other betting companies. They sit on an astonishing 49 times full-year 2011 forecast earnings, falling to 26 times in 2012. Betfair is an innovative company and a great success, but that's too rich for us even after the shares' fall. Avoid.
Our view: Buy
Share price: 574p (+10.5p)
Domino Printing makes machines that print "variable information" labels – things like "best before" dates for food. And a good business it is too: yesterday the company boosted pre-tax profits by 86 per cent from £28m to £52m in the year to the end of October, beating City forecasts. It also posted its 32nd consecutive year of rising sales. The outlook, too, is rosy with the company reporting rising demand.
Revenue is split with 40 per cent from machine sales, and 60 per cent from servicing, where the need for additional ink and maintenance means customers are locked in for the long haul. This means Domino has some protection from economic swings. It also has a good geographical profile, with a third of profits coming from fast-growing Asian markets.
The company has used the downturn to prepare for recovery by upping its research and development investment, and hiring again after it cut staff several years ago. It has no debt and investors will be happy with yesterday's 20 per cent dividend hike, the 25th year of dividend rises. JP Morgan Cazenove values the stock at 15.4 times estimated 2011 earnings, which is only a slight premium on the sector average of 15.1. The company looks good value for it. Buy
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