Veteran income manager Neil Woodford has moved to reassure investors over his holding in outsourcing giant Capita, after a profit warning saw its share price tumble last week. 
Woodford (pictured) said at the start of the week the firm had represented 0.8 per cent of this £7.7bn LF Woodford Equity Income fund and around 1.3 per cent of LF Woodford Income Focus.
“Since the profit warning on Wednesday, Capita’s share price has broadly halved, which has clearly been unhelpful to recent performance,” he said.
As the below chart shows, Capita has fallen by 60.41 per cent in the month to 2 February.
Performance of Capita over 1mth
Source: FE Analytics
Despite last week’s fall, Woodford said he was pleased with the change in the firm’s strategy given the issues it faced in the past.
“This is a complete reset for Capita,” he said. “The new chief executive, Jonathan Lewis, has mapped out a clear new direction of travel for the business and it is one with which I completely agree.
“More focus, better leadership, better cost control, a stronger balance sheet – through a combination of disposals, dividend cut and a future capital raise – which will, in turn, lead to more investment in the business, an enhanced competitive position and a brighter future for its shareholders and customers.”
However, the “complete reset” highlighted by Woodford has been accompanied by the massive fall in share price from what was “an already very depressed level”.
He explained: “After all, Capita represents many of the things that this market loathes at the moment – it is exposed to the UK economy, it has a recent record of disappointment, it is an outsourcer.”
Indeed, the outsourcing community has come under greater scrutiny since the collapse of Carillion earlier this year, which posed questions over the future of private finance initiative projects.
The FE Alpha Manager said that the fall in share price of Capita was the “reality” of his view that markets are being driven by momentum.
“Valuation is irrelevant – it simply does not matter in the stock market at the moment,” he said. “The only question that ultimately matters to me when forming an investment judgement, is ‘what is the company worth?’.
“On that basis, it strikes me that a decision to sell Capita here is almost impossible to justify from a fundamentally-based perspective.”
Woodford noted that Capita announced underlying pre-tax profits of £475m in 2016, when shares were trading at £12. Meanwhile, current guidance for profits – in a year of transition for the firm – was in the region of £270-300m with the share price trading at 165p.
Performance of share price since 2016
Source: FE Analytics
He said: “There are a lot of moving parts and other issues to consider but if this was all you had to go on you might think that, from the perspective of valuation, this is a little bit interesting.”
“There are of course buyers of corporate assets that are not disciples of the momentum school of investing,” he continued, adding that other businesses and private equity buyers are likely to be already circling Capita as a target.
Woodford explained: “I am not trying to make a silk purse out of a sow’s ear – this has been a poor investment, but it is one that has the capacity to become a significantly better one from here.
“There is much work to be done to turn the business around, but there is a clear plan and the project is underway.”
The fund manager said discussions with all major customers and the UK government’s Cabinet Office had gone well. Woodford said the collapse of Carillion had prompted the whole outsourcing industry to rebase its relationship with the government, noting the recognition of both sides to reflect a fairer balance between risk and reward.
Woodford said: “I would go as far as to say that the business will be in better shape at the end of 2018 than it was in 2016.
“It will have infinitely better leadership, a stronger balance sheet, better cash flow, more conservative accounting policies and a lower pension deficit.”
He added; “The mistake I have made, albeit I didn’t know it at the time, was in owning Capita in 2016. It is not a mistake to own it now.
“And so, I will not be compounding the previous error by behaving in an irrational and valuation insensitive way now.”
The fall in Capita’s share price is the latest setback for Woodford’s flagship LF Woodford Equity Income fund, which was hit by stock-specific issues at holdings Provident Financial and AstraZeneca last year. The fund also lost its top five FE Crown rating in the latest rebalance of the crown ratings
“Whilst the stock market remains totally preoccupied with momentum and insensitive to valuation, we should all expect the environment to remain as challenging for the Woodford funds, as it has been since early summer last year,” he said. “I will underperform in such market conditions as I have done before.
He added: “Equally, however, we should expect rationality to return in an unpredictable way, as it has done always in the past.
“When this happens, share prices will adjust to reflect reality in the economy and in the businesses that thrive and prosper within it.”
The manager said he would be doing investors in his funds “a massive injustice if I was to abandon the investment discipline that has guided me for 30 years in this industry”.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
Over three years, LF Woodford Equity Income has delivered a 10.81 per cent total return, compared with a 22.24 per cent gain for the average IA UK Equity Income peer and a 25.28 per cent return for the FTSE All Share index.
The fund has an ongoing charges figure (OCF) of 0.75 per cent and a yield of 3.59 per cent.