With the Capita share price near 25p, it’s dropped by around 47% over the past year.

In fairness, the markets have been terrible and many stocks have plunged. But the business has perhaps earned the poor performance of its shares. Nevertheless, it has turnaround potential now. And I think the opportunity is worth me exploring.

Rapid rise and fall

Capita was the UK’s leading player in creating and developing the outsourcing market. And the business grew at lightning speed after emerging as a standalone company back in the late 1980s. And it diversified its services both wide and deep in the public and private sectors.

Capita seemed to be everywhere. For example, it’s had contracts such as the running of the London congestion charging zone. It’s collected the BBC licence fee, and provided electronic tags for offenders. It’s recruited for the British Army and for the NHS. And it’s been involved in many primary support services for the NHS as well as many other diverse operations in both the public and private sectors.  

The share was a darling of the stock market — until it wasn’t. The company’s rapid expansion into a mind-bogglingly wide spread of services caused an apparent lack of focus. Contracts started becoming unprofitable. And worse still, Capita started mucking things up and getting things wrong with many of the services it was supposed to provide.

The day of reckoning came in July 2015 when the share price topped-out at around 800p. And that’s a lot higher than today’s 25p, which goes a long way towards telling the story of the decline of the business. Indeed, the earnings record over the past few years has been terrible. In 2016, the company posted annual earnings of just over 14p per share. But for 2022, City analysts expect a little under 4p.

Turnaround and debts

One of the outcomes of Capita’s history of ascendancy and decline is a huge pile of debt. It’s a big problem facing the current management team in their efforts to turn the business around. And the company is addressing it in part with a programme of asset sales.

One recent example is the announcement of the company’s intention to dispose of its Pay360 Limited business. And it also completed the sale of its two real estate and infrastructure consultancy businesses in September. All the money raised appears to be going towards debt reduction.

In August’s half-year results report, chief executive Jon Lewis said the company’s reputation for delivery and digital transformation services is increasing. And it’s secured “a series of important contract wins and renewals”. Meanwhile, City analysts predict an increase in earnings of around 34% in 2023 making the forward-looking earnings multiple about five.

Rising annual earnings haven’t been seen for around five years. So, this could be the beginning of a meaningful turnaround. But it’s early days. And the company has a lot of historical ‘baggage’ and debt to shift. Meanwhile, there’s no shareholder dividend.

I don’t think the Capita share price is a particular bargain when adjusting for the company’s debts. The valuation looks fair to me. And the company has much still to prove. So I’m watching from the sidelines for the time being.

Capita shares struggle

Capita is a business process outsourcing company with a focus on consulting, transformation, and digital services. It has operations in the UK, Europe, India, and South Africa across three divisions, which are Capita Public Service, Capita Experience, and Capita Portfolio.

A penny stock is one that trades for less than £1. So what is the current state of play with the Capita share price? Well, it has been on a downward trajectory for some time. The recent stock market correction had an impact on all stocks and some were able to bounce back. As well as this Capita has had its issues in recent years too.

Capita shares are currently trading for 20p. At this time last year, the shares were trading for 42p, which is a 52% decline over a 12-month period.

For and against buying Capita shares

FOR: I took some positives from Capita’s most recent full-year results announced on 10 March. Despite overall revenue and profit falling compared to 2020 levels, Capita said it won £3.8bn worth of new contracts, up from £2.9bn in 2020. A penny stock with unmanageable debt levels is usually a red flag for me. Capita reported it has made some good headway reducing its debt level.

AGAINST: One of the biggest issues I have with Capita is the fact it seems to be struggling with contract attrition. It anticipates that increased attrition rates will have a material impact on revenue growth and financials ahead. This would affect performance and returns.

FOR: The shares do currently look dirt-cheap on a price-to-earnings ratio of just two. Another positive is that Non-Executive Director John Cresswell purchased 45,000 shares after 2021 results were announced last month. Insiders buying shares is always a positive in my eyes. If those who know best the direction and potential of a business are willing to part with their hard earned cash to buy shares then maybe I should too.

AGAINST: I do understand that past performance is not a guarantee of the future, but in Capita’s sector, reputation is crucial. It has lost contracts in the past based on being unable to deliver agreed duties. One instance that springs to mind is an NHS contract it lost when it failed to provide reminders to patients for cervical screenings. The NHS bought this service back in house after these issues. This could affect future contract negotiations and wins.

A penny stock I’d buy

Small caps are often seen as risky investments. I like to look out for small-cap shares that are showing signs of potential for the future ahead. The full-year results, especially debt reduction, lead me to believe Capita could experience growth in the longer term ahead. Insiders buying shares is also a sign of confidence too. I’d buy a small number of shares and hold on to them for the long term although I do expect some turbulence in the short to medium term.

As such, here are three penny stocks I would acquire for my portfolio today. 

Penny stocks for growth

The first company is retailer Card Factory (LSE: CARD). After a tough couple of years, the business may see a recovery in 2022. 

According to the group’s latest trading update published at the beginning of November, sales had recovered to near pre-pandemic levels by the third quarter. The company has also been able to substantially reduce net debt, putting it in a solid position to return to growth next year. 

Despite the return to growth, the stock is trading at a relatively attractive forward price-to-earnings (P/E) multiple of just six. That seems too cheap to me. 

The group may face risks as we advance, including the supply chain crisis and higher costs due to wage inflation. This could have an impact on profit margins. 

Outperforming expectations 

This year, one company that has outperformed all expectations is the automotive retailer Pendragon (LSE: PDG). Booming demand for second-hand vehicles has pushed used vehicle prices to record highs, and the corporation has been able to capitalise on this demand.

City analysts are forecasting a net profit for the group this year of £51m. This projection is based on management’s own forecasts. If the company hits this target, it will be the first time it has earned a profit since 2017. 

And, once again, despite this incredibly attractive underlying fundamental performance, the stock is extremely cheap. It is trading at a P/E ratio of just 4.7, based on earnings projections for the current financial year. Unfortunately, analysts are expecting growth to slow next year. Still, even on these lower growth projections, the stock looks cheap. It is dealing at a 2022 P/E of 6.7. 

Investors may be worried about the company’s high level of debt. This could become an issue as interest rates begin to rise. A drop in used-car prices may also hurt group earnings growth. 

Outsourcing demand 

Capita (LSE: CPI) recently published a depressing trading update. The company warned that contract attrition would have an impact on revenue growth as we advance.

This is disappointing, but the enterprise has made substantial progress in other areas. It has made a material reduction in net debt over the past couple of years and built sustainable foundations for future growth. 

It seems likely the company will continue to encounter turbulence in the near term. Overcoming contract attrition rates will be the biggest challenge the group has to deal with in the next year or so. 

However, I am willing to take a risk on this company for my portfolio of penny stocks considering its depressed valuation. The shares are selling at a forward P/E of just 7.8, falling to 5.4 for 2022. 

Should I use this opportunity to buy the stock?

Capita’s recent trading update

Capita sees an improving trend in its trading performance. It expects revenue growth in 2021 and this is the first time in the past six years that the company has had revenue growth. Revenue had dropped from £4.36bn in 2016 to £3.32bn in 2020. Most of the companies I have reviewed had decent growth in that period. I believe this is one of the reasons for the company’s low stock returns. 

The company won significant contracts this year, which in my opinion, should help to support the falling Capita’s share price. Some of the notable contracts include the Royal Navy Training contract for £925m. The company is one of the leading contractors for the UK government. In addition, the customer management segment got an extension of a European telecoms client contract for £528m. With these new contracts, management expects the current half-year adjusted revenue to be flat. 

Capita’s cash collection is in line with the improving trading performance, which helped increase liquidity to £689m as of 17 June 2021. It has a loan repayment of £160m in July 2021. This year, the company had set out a plan to strengthen its balance sheet by disposing of the non-core assets. It also recently announced the sale of Axelos, a 51% joint venture with the Cabinet Office, which will generate cash proceeds of £184m for the company. Capita’s share price rose when the deal was announced on 21 June 2021. 

The company’s plan to restructure its business is also progressing well. It will have two core divisions in the future: Capita Public Service and Capita Experience, and a third division, Capita Portfolio, will hold the non-core assets. This will save the company about £50m of annualised cost savings from 2022 onwards.

Some of the risks to consider

The company has high debt. As of 31 December 2020, the company had net debt of £1.1bn. In contrast, the company’s market capitalisation is only about £650m. The high debt is also one of the reasons for Capita’s share price to remain low. 

Capita’s contracts with the NHS in the past have been criticised as they failed to meet the requirements. For example, cervical screening patients were supposed to be sent an invitation and reminder letters. However, the company had failed to do this. As a result, the contract was scrapped and NHS had to bring the service back in-house.

Final view

The restructuring of the business, in my opinion, is the right step for the company. However, the high debt is still a concern. Also, there is still uncertainty about the long-term growth of the company. So I will keep the stock on my watchlist for now. 

However, not all UK shares are flattish today. Here’s why these British stocks are either powering ahead or plummeting in start-of-week business.

Senior soars on new offer

The Senior (LSE: SNR) share price has soared 11% in Monday business, taking total gains over the past year to 123%. The small-cap has soared to 169p after suitor LSF XI Investments returned with an increased offer price.

Senior — which has rebuffed LSF’s acquisition attempts four times prior to today — said the cash offer terms had been improved to 200p per share. This is up from LSF’s last bid of 185p, which was rejected last week.

UK defence share Senior is perhaps best known for building parts for the aerospace industry. It’s been hit hard by the impact of Covid-19 on the civil aviation sector and latest financials showed sales at its Aerospace division fell 25% year-on-year in the first quarter.

Ilika continues to lose power

Ilika’s (LSE: IKA) share price has, by contrast, sunk in start-of-week trade. Down 5% on the day at 147.5p, gains for the past 12 months have been trimmed to a still-mighty 173%. Investors have sent the UK electronics share to six-month lows following the release of fresh trading numbers.

The solid-state battery maker said revenues dropped 18% year-on-year to £2.3m during the financial year to April. This, in turn, prompted its adjusted EBITDA loss to widen to £2.3m, from £2.1m a year earlier.

Ilika also said cash and cash equivalents had fallen £5m year-on-year to £9.8m. The business will release full-year results on Tuesday 6 July, it said.

UK share Capita rises on trading and disposal news

The Capita (LSE: CPI) share price meanwhile has leapt 6% following the release of fresh financials. Though at 39.85p, the FTSE 250 share still trades 18% lower than it did a year ago.

The UK support services share said it has enjoyed “an improving trend in our trading performance in the first half of the year.”

As a consequence it expects to record its first annual sales rise for six years in 2021. Capita also said it’s won a number of significant contracts including The Royal Navy and Tesco Mobile. The outsourcing giant added that it continues to make “good progress” with its cost-reduction programme.

In other news, Capita said it has agreed to sell its 51% stake in AXELOS Limited to PeopleCert International. The best practice business — a joint venture established with the Cabinet Office in 2013 — will provide Capita with a total cash windfall of £183.6m.

FTSE 250 commercial property developer Hammerson (LSE: HMSO) looks good to me. In 2020, Hammerson recorded a statutory loss of £1.7bn. That’s mainly down to property revaluation, though. Net rental income was down 41% to £158m, but it could have been a lot worse. And the company put its adjusted earnings at £36.5m, with adjusted earnings per share at 1.6p.

There has been a rights issue, and the company has disposed of some assets to free up cash. That’s helped get the liquidity situation looking healthy enough to me. Net debt actually dropped in 2020, to £2,234m. And the company reckons it had liquidity of £1,748m, including £503m in cash. As the economy strengthens, Hammerson must be well positioned to benefit, mustn’t it? Well, there’s still plenty or risk attached to commercial property. Business isn’t exactly booming yet. And any Covid, or economic, downturn could cause pain. But I have Hammerson on my penny shares short list.

Set for recovery?

Next up is outsourcing specialist Capita Group (LSE: CPI), which I have down as a recovery candidate. Capita has been through a terrible patch, plunging to big losses. The share price has followed suit, crashing more than 80% over the past five years. Even the Covid-19 crash looks relatively benign when seen against Capita’s woes. So why would I consider buying a penny share like this?

It’s all about the company’s 2020 results, which included a return to positive free cash flow. The company put that down to “higher cash conversion and improved and sustainable cash collection“. Net debt also came in better than expected, down 20%. And the firm’s gearing was “well within covenants“.

All this looks positive. But the key development for me is that Capita said it expects to achieve sustainable cash generation in 2022. Now, I’m still seeing a fair bit of risk here. And I reckon Capita might even dip further into penny share territory before turning round. But I’m optimistic.

AIM penny shares

Turning to AIM, penny shares there go down as low as 0.05p. But moving up the list of prices a bit, I do like the look of HSS Hire (LSE: HSS). Several of my Motley Fool colleagues have been positive about HSS in recent months, including Rupert Hargreaves who took a look in May.

As Rupert pointed out, HSS, along with the sector in which it operates, suffered during the crash. But it’s coming back, with an 80% share price rise so far in 2021. It was higher in April and has fallen back since then, mind. Still, when reporting 2020 results in April, HSS was upbeat about this year. The company told us “We have had an encouraging start to 2021, with EBITDA in the first quarter ahead of 2019 and 2020 levels“.

There’s certainly risk here, as there is with the three of these. A further Covid wave, or even an economy weaker than expected, could set them back. But on balance, I’m tempted to buy these penny shares.

Growth outlook

During the past five years, Capita has encountered problem after problem. Many of these issues were of the company’s own making. The outsourcer consistently underbid for contracts in the past, which meant it had to cut corners to improve profits.

Ultimately, the group couldn’t keep this charade up forever. In 2016 and 2017, operating losses totalled nearly £500m as the group tried to correct past issues. Since then, the firm’s been shrinking.

Revenues fell to £3.3bn in 2020, down from £4.7bn in 2015. Management’s been selling off non-core businesses and exiting unprofitable contracts to improve overall performance. This has had an impact on both the top line and the Capita share price. 

However, the company believes it’s now put the worst of its problems behind it. In its full-year results release, the firm said it expects to return to organic revenue growth this year and achieve sustainable cash generation in 2022. If the group manages to meet these aims, I think it’ll mark the successful conclusion of its multi-year turnaround plan. 

This, in turn, could translate into a re-rating of the stock. At the time of writing, shares in the outsourcing business are changing hands at a forward P/E multiple of 6.9. That’s compared to the market average of around 17. I think this low multiple shows what the market thinks about the firm. It doesn’t trust the company, and that’s understandable considering its past. 

But, if the group does return to growth, I think it’s not unreasonable to say the Capita share price deserves a higher multiple. 

Of course, these are only projections and estimates at this stage. There’s no guarantee the firm will be able to return to growth next year. And there’s no guarantee City analysts are correct in their estimation of how the company’s earnings will evolve over the next 12 months.

Capita share price challenges

If the firm runs into significant problems with historical contracts, which it has done in the past, this could derail its recovery. In this situation, investors may desert the Capita share price once again. 

There’s also the issue of debt. Capita has been trying to reduce its borrowings for the past five years. It has succeeded to a certain extent. Net debt has declined from around £2bn in 2015 to £1.1bn at the end of 2020.

Unfortunately, this level of borrowing still looks high compared to the company’s market capitalisation, which stands at £780m. Creditors have been happy to support the corporation up until this point, but there’s no guarantee they’ll stand by the business forever.

Despite the risks and challenges the company faces, I think the Capita share price looks cheap. That’s why I’d buy the stock today as a recovery play within a diversified portfolio.

A penny share in name only

Capita (LSE:CPI) is a UK-based business that operates in a variety of areas. The bulk of the business comes from public sector work, servicing outsourced projects that need professional services. These can range from payroll and financial details, to broader based consultancy work. It also works with the private sector in the same fields.

Capita is a penny share, with a price around 47p. The share price has fallen over the past few years, and last traded above £1 before the pandemic hit last year. This shows to me that there’s potential for the share price to double, given that it’s been there only a relatively short time ago. 

I think the outlook for the stock is positive. Over the past couple of years, the business has been trying to simplify operations and focus on profitable areas. Covid-19 has impacted the business, but half-year revenue was only down 9%, showing me that the company is resilient. It also boosted adjusted free cash flow during the period to £176m from £30.1m in 2019.

The risk with Capita is that even if private sector work recovers, public sector projects may be thin on the ground due to fiscal cuts. So the company may need to tilt more to bidding for private sector work to compensate.

A nod to lockdown cooking

Premier Foods (LSE:PFD) just sneaks in as a penny share as it’s trading at 99p as I write. The British food manufacturer owns many well known brands including Mr. Kipling, OXO and Angel Delight. The share price is up almost 350% over a one-year period, but I think it could still climb further. 

A lot of the boost over the past year has been due to larger consumer demand for products due to restaurant closures. For example Lloyd Grossman sauces are an easy addition (as I well know) to home cooking during lockdown. I think that this demand should continue even as we move out of lockdown.

I think people are more cost conscious given the hit a lot have had to their income. So even with restaurants back open, I still believe home cooking levels will be higher than pre-lockdown. In a recent study Premier Foods carried out, it revealed that “91% of Brits intend to cook as much, or more, over the year ahead”.

Some think that having already delivered impressive returns, the share price may be vulnerable to a share price correction. I acknowledge this as a potential risk, but I don’t see it as enough of a plausible argument to worry me about the longer-term growth story.

Prior to the pandemic, the share price was hurt on the back of its rival Carillion’s collapse in 2018. The outsourcing sector has suffered since then and the Capita share price has struggled with it. A string of profit warnings have added to its woes and despite its recent rise, the share price is down 63% over 12 months.

New CEO, Jonathan Lewis joined Capita in 2017 to turn around the company’s fortunes. But do I feel it has turned a corner under his leadership? Not yet! 

What does Capita do?

I must admit that Capita can be a hard business to understand. I think the problem is that the company has its finger in so many pies that it’s really difficult to know what’s going on. 

In a nutshell, Capita is a consulting, digital services and software business. At least this is how it describes itself on its website. It’s also an outsourcing firm that operates both in the public and private sectors. 

It has six divisions and revenue from each business is relatively evenly distributed. While the business is somewhat complex to understand, at least it has diversified its revenue, although some might say it’s too diversified.

Strategy

When Lewis took over as CEO he concluded that Capita worked across too many markets and services. I agree with this point. In fact, I think it’s very difficult to maintain a competitive advantage in every business.

Lewis also pointed out that Capita had relied too much on acquisitions to drive growth and had also seen weakness in the quality of new contracts. His strategy is very simple. It’s to simplify the portfolio of businesses, focus on higher-quality contracts and strengthen the balance sheet. But I think this is easier said than done.

This means that there have been disposals of businesses and the proceeds have been used to strengthen Capita’s financial position. The funds will be used to reduce the large net debt position and pay down pension liabilities. I think it’s encouraging to see Capita reduce its leverage, but this will take some time to yield results.

Recent events

Capita has struggled during the pandemic. Revenue was not only hit by Covid-19 but also by 2019 contract losses. Yet the shares have risen on the recent flurry of positive news. It has signed a contract to deliver training services to the Royal Navy. Last month, Capita completed the sale of its Education Software Solutions business.

It also recently confirmed media speculation that it’s looking to sell its AXELOS business. This is a joint venture with the UK Cabinet Office where Capita owns 51%.

What next for Capita shares

There are a few bright spots for the company. The disposing of assets means that the debt pile can be reduced faster. Capita has also focused on securing higher- contracts as evidenced recently with the Royal Navy. This could mean a brighter future for the firm. Yet I think it’s still early days and there’s no guarantee that the turnaround will be successful. For now, I’ll sit on the fence and monitor the shares.

Cheap stocks weigh risk vs reward

Capita Group is a consulting, digital services and software business. Since Carillion collapsed in 2018, the outsourcing sector has been suffering. Capita comes under this banner and has not escaped the backlash. Prior to the pandemic hitting, it endured a string of profit warnings. Under new leadership, it’s now aiming to win higher quality and more lucrative tech contracts, as well as streamlining assets.

Its AXELOS division is a joint venture with the UK government’s cabinet office. Capita has confirmed it’s in talks to review and potentially sell AXELOS. This is to help streamline the business and keep it afloat as its share price has been hammered by the pandemic. It already completed the sale of its education services business (ESS) earlier this month, and the proceeds are being used to pay down the balance sheet.

The Capita share price has fallen 94% in five years. It’s down 73% in the past year, and its share price has experienced considerable volatility during this time.

The FTSE 250 company recently signed a contract to provide training services to the Royal Navy and the Royal Marines. And in December it secured a two-year contract extension with the Ministry of Defence (MoD) to recruit for the British Army.

Capita’s price-to-earnings ratio (P/E) is just 2. Warren Buffett considers anything under 10 to be in the value category so this certainly shows a cheap share. But cheap is only a bargain if it can go the distance and recover. Earnings per share are 18p, and the company doesn’t offer a dividend.

Capita has close ties to the UK government and British establishment. For instance, it collects the BBC TV licence fees. However, it has a 94% debt ratio, which is clearly unattractive. Nevertheless, it’s trying to pay this down by trimming assets, so it looks as if there’s room for a strengthening balance sheet and share price growth in the future. Despite all its problems, I think it will overcome them and I’d be happy to invest in Capita.

Sustainable investing

The Biffa share price is down 21% in a year. It’s a waste management company that’s suffered from losses due to so many public spaces being closed. However, as the country reopens, I imagine revenues will rise again. It spent £40m on acquisitions between June and November. It also intends to spend the same again on green infrastructure. Biffa has a P/E of 12 with EPS of 18p.

Its Q3 trading update released in January showed resilience with better than expected results. The company opened a state-of-the-art plastic recycling plant in Seaham a year ago. Biffa aims to quadruple its plastic recycling capabilities by 2030 and recently partnered with Nestlé Waters UK to provide it with bottles made from recycled British plastic.

Sustainability and a green agenda is on every government’s radar at the moment, so I think this is a good sector to be investing in.

These are both high-risk cheap stocks, but I’d consider adding them to my Stocks and Shares ISA as long-term investments. I think they both have a good chance of survival and growth ahead.