Why I'd sell 60%-slumping Capita plc to buy this small-cap stock
The last year has been a disaster for investors in Capita(LSE: CPI). The support services company's shares have fallen by 62% in that time, experiencing severe challenges regarding its financial performance.
Further difficulties could be ahead as the business seeks to turn around its performance. That's why it may be worth avoiding it in favour of a smaller company which released an encouraging update on Monday. While potentially risky, it could deliver higher returns than its larger peer.
Impressive outlook
The company in question is global Spend Control and eProcurement solution provider Proactis (LSE: PHD). Its revenue and EBITDA (earnings before interest, tax, depreciation and amortisation) growth during the first six months of its financial year has been strong. It now expects to report a rise in revenue of 123% in the full year, with EBITDA now forecast at 183% higher.
The acquisition of Perfect Commerce is making a significant impact on the company's performance and has traded in line with expectations since the purchase. The company has also made strong progress in delivering the cost synergies it identified at the time of the acquisition. The net annualised value of those synergies made to date is £3.3m, with the business on track to deliver on its target of £5m by the end of the financial year.
With Proactis forecast to report a rise in its bottom line of 28% this year, followed by growth of 26% next year, it seems to be delivering on its potential. It trades on a price-to-earnings growth (PEG) ratio of just 0.4, which suggests that it could offer a significant upside. As such, while a relatively small business, it could be worth buying for the long run.
Challenging outlook
While Capita may be able to deliver a successful turnaround under its new management team, the company's prospects appear challenging. It's expected to report a bottom line decline of 34% this year, followed by a further fall of 3% next year. This could cause investor sentiment to dip yet further, and may mean its valuation comes under pressure.
Furthermore, it's likely to take time for it to reorganise its asset base and to see the return on planned investment in core areas. Within a difficult marketplace, this could mean that it delivers several years of disappointing profitability. And even though it's seeking to conduct a rights issue of up to £700m, the cost to turn around its overall performance could lead to a degree of pressure being placed on its financial resources.
Certainly, Capita's price-to-earnings (P/E) ratio of around 6 is relatively low. It could indicate a wide margin of safety is being applied by investors. However, it may also prove to be a value trap, since it appears to lack a clear catalyst to push its share price higher. As such, it seems to be a stock to avoid at the present time.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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