A profit warning from government contractor Capita sent shares tumbling across the sector on Wednesday, just two weeks on from the collapse of construction giant Carillion.
The announcement from the outsourcing firm, responsible for administration teachers’ pensions among many other key public sector contracts, marked another stumbling block for a troubled sector.
Interserve, Serco and Mitie Group, all big players in securing public contracts from local authorities and central government, were among the fallers.
Transformation: Capita’s boss has spent the first two months in the job drawing up a ‘transformation’ programme to turn the company’s fortunes around
Data from Tussell, a research firm that examines the government’s ‘strategic supplier’ contracts with these big firms, found Capita was by far biggest supplier and won 47 per cent of contracts put out to tender over the last two years.
Since a previous profit warning in September 2016, Capita won 193 public contracts worth £194million.
It has also been listed as a preferred supplier, known as being on the ‘framework’, for 226 government buyers since January 2015 with an estimated value of £4.2billion.
Mitie Group and Interserve secured around 110 and 84 different contracts respectively over the last two years, with Carillion a seemingly small player having secured around 18.
Should we be worried that another failure similar to Carillion’s collapse,or even more serious, is on the horizon then?
In the wake of Capita’s announcement a spokesperson for Prime Minister Theresa May said they did not believe ‘any of our strategic suppliers including Capita are in a comparable position to Carillion’.
However, these companies are struggling with ever tighter margins as firms looking to outsource seek to do it for the lowest possible price with ever shorter timescales.
Construction giant Carillion was forced into liquidation two weeks ago – now people are asking if the likes of Capita and Interserve could go the same way
The UK’s slower economy and the uncertainty caused by Brexit have meant times are tougher.
‘The services these companies provide are done at very low margins,’ Helal Miah said, an investment research analyst at The Share Centre. ‘It is all well and good when times are good and even on low margins you can make reasonable profits, but when times turn things flip really badly.’
Just last year, following its own profit warning, Serco boss Rupert Soames said in an interview that the firm had some ‘great political uncertainties looming over us’, with ‘capricious’ governments changing their mind or calling elections.
These difficulties have shown through in the share price. Serco, a FTSE 250 company, has watched its share price fall from £6.27 in July 2014, to just 92p today.
Capita is one of the biggest government contractors having secured 47 per cent of the contracts tendered over the last two years. Running London’s congestion zone is just one of many projects it is responsible for.
Prior to Wednesday’s announcement, Capita’s shares had steadily fallen over the past three years. From a high of £13.04 in July 2015, on Wednesday they traded at just £2.60.
Other large firms such as Kier has seen its share price fall from a highpoint of nearly £19 a share in 2014 to low of £10.53 in July 2016. Today Kier trades at £10.56.
Mitie Group, the UK’s largest facilities management company which employs 53,000 people, has also witnessed a drastic fall in its shares from £3.11 three years ago to £1.77 today.
This all before we tackle Interserve, which just four years ago traded at £7.30 but fell to below a pound earlier this month. On Wednesday it was priced at £1.08.
One common theme, says Miah, is that they are all companies primarily focused on work in the UK.
Other firms battling for government contracts such as G4S, Balfour Beatty and Sodexo all have more international business and large exposure to the USA.
Those left standing could actually benefit from the failure of companies such as Carillion though, according to Joe Brent, head of research at analyst group Liberum.
‘There is lots to worry about in outsourcing at the moment but don’t forget that most of Carillion’s problems were in construction and some of the issues were stock specific,’ he said.
‘For some companies, the issues at Capita and Carillion present an opportunity to win market share, for example Balfours and Costain in construction and Mitie in outsourcing.’
An ingrained problem among most of the firms is on the balance sheet, with high debt levels.
‘The sector in general does operate on relatively large debt levels, that’s part of the problem. We have to look at how we remunerate these companies,’ Miah said, adding that many have expanded too soon and are getting too big.
Government projects such as Crossrail are outsourced to companies to complete. The contracts can be worth hundreds of thousands, if not millions, of pounds to private firms.
Brent says the company facing the biggest balance sheet risk is Interserve, which saw its share price plunge 15 per cent last week after being placed on a government watch list.
‘If [Interserve’s balance sheet] cannot be addressed through a rights issue it could be terminal for the stock,’ he said.
Unlike G4S and Balfour Beatty which witnessed these core issues several years ago, the big UK-centric strategic suppliers have been late in addressing their problems, or in the case of Carillion covering them up.
In Capita’s defence, Charles Stanley economist Garry White says it is unlikely it will go the same way as Carillion for exactly the same reason G4S and Balfour have managed to bounce back – it is tackling its problems early.
‘Management at Capita have a plan to rectifying its indebtedness. Mr Lewis appears to have a plan to prevent it going the way of Carillion,’ White says.
‘It is expected to remain profitable and the rights issue should help shore up its finances.’
However, challenges for the sector as a whole remain as both central and local government tightens its belt and the UK economy stagnates.
Miah added: ‘The companies are being squeezed on all sides, unfortunately they will continue to be unless the UK can pick up, but for the time being it is going to be an extremely difficult time.’
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