10 November 2016 | Graeme Davies
Investor confidence in the support services sector that FM firms occupy has been rattled after two established players issued profit warnings that laid waste to their share prices.
While both Mitie and Capita have their own issues there were common themes running through their trading updates, not least of all uncertainty among customers either side of June’s EU referendum. Both companies suffered during the weeks around the vote as customers sat on their hands and held off from committing to new business.
This is not unique to the sector or these companies as many areas of the economy slipped into a temporary lull in May and June, but for Mitie and Capita this was compounded by problems within their own businesses.
Both companies have in recent years pursued growth organically and through acquisition with some success. But costs associated with such growth have begun to bite as revenues have come under pressure as demand has slowed. And both firms accompanied their profit warnings with news of cost-cutting measures designed to realign their businesses. This will incur more costs in the short term, but should leave the businesses in a better state for current market conditions.
The problem with the relatively low-margin business that many support services companies do is that the margin for error is minimal, so when a hike in costs such as the National Living Wage is introduced, margins rapidly dwindle. And individual contract issues can have a significant effect. Capita has stumbled over the delivery of a contract for Transport for London for its Congestion Charging scheme, where delays are likely to lead to one-off costs of between £20 million and £25million.
Its woes have raised wider concerns among City analysts about the company’s business model and its means of achieving the growth rates investors have become used to through acquisitions. Some analysts have questioned how they can value the true underlying company, such are the adjustments made to its accounts to reflect acquisitions. The scale of the sell-off in Capita shares following the profit warning reflected this concern – it lost a third of its value in one trading day.
Mitie and Capita are likely to hold back on acquisitions and prune their costs bases to return to an even keel. Ironically, this could give investors a more accurate view of the real health of the underlying businesses.
Graeme Davies writes for Investors Chronicle