Investment Column: Capita set to benefit from state outsourcing
Inmarsat; Avon Rubber
Wednesday 12 May 2010
Our view: hold
Share price: 775.5p (-24P)
Regardless of what sort of government we get, and how long it lasts, one thing that is abundantly clear is that public spending will be slashed to lower the gargantuan budget deficit.
This bodes ill for some companies (defence contractors, for instance, may be hit as the country pares back) but is positive for outsourcers such as Capita, which stands to gain from the impending efficiency drive. The company, which, among other things, collects television licence fees, is alive to this opportunity and said yesterday that it expected outsourcing to "play a key role" in the new government's bid to put a leash on spending.
That said, the political picture is uncertain, with little clarity about whether cuts will be start this year or next. The short- to medium-term case for Capita, then, seems to rest on the valuation, in our view. Let us begin by contrasting Capita with Serco, another widely followed outsourcer.
Looking at the picture over the past year or so, more consistent end markets have helped Serco to steal a march on Capita's shares, according to recent analysis by Credit Suisse. Serco also appears to offer less in the way of upside, which the broker estimates at 17 per cent in terms of Serco and 20 per cent in terms of Capita. Capita is trading on 18.7 times forecast full-year earnings. The Credit Suisse analysis puts its historical trading range at between 15 to 24.
So Capita is not particularly expensive but neither is it so cheap to offset the short-term political uncertainty that faces it and its business model. In July we said buy the shares at 695p. They are now at 770p, so they've done us proud. We wouldn't be buying any more at the moment, but this is a company we believe should reward those who hold over the medium term.
Our view: Hold
Share price: 759.5p (+0.5p)
Inmarsat is an example of a business whose services came into their own in the last quarter. It provides voice and data satellite services to ships, aeroplanes, the military and other workers in remote areas. As such, demand for its services shot up as a result of the earthquakes in Haiti and Chile, so it produced some very good results.
Mercifully, however, such events are rare and revenues from land-based voice and data users will inevitably be volatile. So how are the more predictable parts of Inmarsat's business doing? It's a mixed picture. People on ships are making fewer calls than they were, and the lost revenue is only just being offset by them turning to alternatives such as email. To accelerate the development of this business, Inmarsat has hinted it could move to satellite broadband technology, but that would require heavy investment.
Aeronautical services are growing very quickly and would boom if mobiles phones were allowed on flights, but at the moment the base is quite low. Strategically, we like the company's use of cashflow to pay down its debt. Also, its earnings before interest, tax, depreciation and amortisation rose by 22.8 per cent to $144.1m, when the market had forecast $130m.
Those who followed our advice to hold the shares at 621p in November did well. With the stock trading on 23 times this year's forecast earnings (falling to 19.6 times next year's), it is not cheap and has been fattened by bid rumours. We wouldn't blame anyone for taking profits but we still think Inmarsat is a solid, long-term hold.
Our view: buy
Share price: 93.5p (+8p)
What links diary farmers and infantry soldiers? Not an awful lot, you would be right in thinking – apart from rubber, that is. Avon Rubber makes a range of products from those found on the farm, to gas masks that are used by troops. Yesterday, its shares jumped by a stunning 8.8 per cent after it reported a storming 48 per cent increase in first-half profits.
In fact, there was nothing but good news in the statement: Avon's order book is in healthy order, while the management declared itself upbeat about prospects for the coming months. If there was a fly in the ointment it was that the stock increased by so much, putting the shares on something closer to fair value than they had been earlier. There is no dividend, so any new investors will depend on an upwardly mobile share price.
But worry not, analysts at Arden say there is still room for growth. Avon's shares trade on a 2010 price to earnings ratio of 10 times, they say, implying a fair value share price of 123p. While valuations are not always necessarily met and things can go unexpectedly wrong for small companies such as Avon, we see no reason not to invest in the shares. Buy.
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