After the spectacular collapse of Carillion in January, who’d go near the outsourcing sector? Well, I would.
Rock bottom?
I’ve actually been pretty scathing about Capita (LSE: CPI) after tough trading conditions led to a price collapse, and I’d been fearing further bad news which could make things even scarier. For years we had a company paying out around half of its earnings as dividends while shouldering big debts, and I reckon that was madness. But I think things are changing.
Firstly, that unwise dividend was eliminated when full-year results were released. But, you might ask, how can I then select it as a dividend stock for retirement? Well, at the time, the firm said it “recognises the importance of regular dividend payments to investors… and will consider the payment of dividends once Capita is generating sufficient sustainable free cash flow.“
If Capita can get back to generating that cash, I can see decent dividends being reinstated, and that long-term outlook is what drives my thinking. And I’m starting to think that there’s too much pessimism in the share price just now — even though it has been picking up.
Tuesday’s news of a new MoD contract has pushed the shares up 6% at the time of writing, after the company confirmed it has been chosen to run the UK military’s fire and rescue services. The deal was politically controversial, and it had been narrowed down to Capita or Serco.
The MoD’s apparent assessment that Capita is financially sound is welcome, and though there are still a couple of tough years ahead, I think the turnaround point could have been reached. I think Capita shares are now worth the risk.
Growth and dividends
Kier Group (LSE: KIE) is another in the sector whose shares have been hit hard, but forecasts are still looking pretty decent, there’s still a big dividend on the cards, and valuations appear very low.
In fact, we’re looking at forecast P/E multiples of only around 8.5 this year, dropping to 7.7 by 2019. With EPS expected to grow by around 10% per year, that gives us PEG ratios of 0.9 and 0.7, which are attractive by growth standards.
On top of that, dividends are predicted to yield 7% per year and would be around 1.8 times covered by earnings. What’s not to like about that?
Actually, we again have the issue of a company paying big dividends while shouldering a fair bit of debt. In this case, Kier reported net debt of £239m at 31 December 2017, up from £179m a year previously. But at least the company reckoned it should be reduced to less than one year’s EBITDA by 30 June, and that’s a figure that really shouldn’t cause any big trouble. Kier’s pension deficit was reduced to £19m too, which looks fine.
Having said that, I still can’t quite square the idea of paying very big dividends while holding high debt, and I’d prefer to see Kier reduce its dividend yield, perhaps to around 5%, for a few years and use the difference to pay down some debt. That, I think, could restore some of the confidence that has been lost.
Kier shares look good long-term value to me.