The Investment Column: Capita is set to profit from cost-cutting firms

Imperial Tobacco; Probability

Our view: Buy

Share price: 670p (+1p)

Capita, the outsourcing group which runs London's vehicle congestion charging scheme, is on a roll. More business is coming in as companies off load back office services to save costs. Life and pension funds are the latest to shed information technology and administration work. Budget-stretched town halls continue to look at tasks which can be handled cheaply by outside contractors.

Against this background it is no surprise Capita cruised to half year pre tax profits of £120m, up 16 per cent. Shareholders get a 20 per cent increase in their dividends. The group secured £626m of contracts during the half to June and has picked up a further £187m since then. The total bid pipeline has grown from £2.5bn in February to £3bn. Analysts estimate the potential market is worth £94bn, with only 5 per cent outsourced so far. Capita's customers are evenly split between the public and private sector, giving it 20 per cent of the market. The present crunch is forcing both groups to look at ways of achieving efficiency by farming out work – a lot ending up in countries such as India. There are plenty of acquisition opportunities. Capita bought eight businesses for £129m in the half-year, its busiest ever spell. It says sellers are now being more realistic about prices.

If the market had any gripes, it was that organic growth appears to have fallen from 17 per cent in the second half of last year to 14 per cent, and on 20-times forecast earnings the shares are fairly well valued. Even so, Capita has proved remarkably resilient during the recent market falls and is likely to be an early beneficiary of any improvement in sentiment. Buy.

Imperial Tobacco

Our view: Hold

Share price: 1,797p (+29p)

Imperial Tobacco shares have fallen nearly 20 per cent in the past three months, putting into doubt its status as a defensive stock. Bans on smoking in public places and weighty tax rises have forced the group to turn to developing countries for future growth as it attempts to manage the steady decline in cigarette consumption in established markets.

After stripping out acquisitions and other factors, cigarette volumes for the nine months to the end of June were up 3 per cent at 147 billion, which is more or less what Imperial expected. In the UK, where smoking was banned in pubs and restaurants last year, the overall market fell by 6 per cent.

Imperial, whose own market share weakened by 0.6 per cent to 45.9 per cent, estimates that half that decline was caused by the smoking ban. In Germany, the impact was even greater, accounting for 3 per cent of the overall 5 per cent drop. However, Imperial grew its market share slightly.

Throughout the rest of Western Europe the market fell by about 3 per cent – or 4 per cent in the case of France. Brokers were generally comfortable with the performance, although Imperial's growth of 4 per cent in the rest of the world was a little less than expected. Ukraine and Turkey did well, however.

A heavily discounted £5bn cash call in May helped fund the purchase of Altadis, its French-Spanish rival, best known for Gauloises and Fortuna, which is bedding in well. Major restructuring involving the loss of 2,440 jobs and closure of six factories, will deliver hefty savings by 2010. Selling on 13 times expected earnings, the shares look fairly valued. Hold.

Probability

Our view: Speculative buy

Share price: 46p (+2p)

Vodafone stunned the market with news of a sharp downturn in mobile phone use in Europe. But one service seems to be thriving. AIM-listed Probability provides gambling games such as casino, bingo and fruit machine on mobile devices.

Its chief executive, Charles Cohen, is attracting 1,000 new customers a week. There are now 300,000 subscribers driving the business towards expected profitability in 2009. For 2008, its losses have been reduced by 70 per cent to £1.1m on a sharp leap in revenue. Mr Cohen says the trick is to keep players hooked by coming up with new games every six to eight weeks. The profile of a typical customer is surprising – about 55 per cent are women aged around 29 who play bingo and slots.

Winnings can be substantial. One customer collected £1,500 for a £10 wager, while another walked off with £211,000 after a two-day winning run on a mobile blackjack game.

The company spends heavily, attracting customers using advertisements on Vodafone and other networks. All players are vetted to ensure no one is under age. The company's profile was greatly enhanced when Michael Spencer, the boss of inter broker dealer ICAP, took a near 16 per cent stake at 50p a share, although they are now back to 46p. A speculative buy.