Outsourcing Decline Will Pressure Margins Though Digital Efforts Boost Outlook

Key Takeaways

• Accelerating digital transformation and AI adoption generate strong growth opportunities, but automation threatens traditional outsourcing revenue and margins.
  
• Heavy investment in technology and restructuring provides efficiency gains, yet operational complexity, public sector reliance, and talent constraints limit scalability and margin expansion.
  
• Accelerating decline in legacy services, persistent losses in underperforming segments, lagging transformation, weak cash flow, and regulatory risks threaten profitability and strategic flexibility.

Catalysts

Operates an outsourcer that supports clients across the public and private sectors in the United Kingdom and rest of Europe.

• While Capita is well-positioned to capture new demand as organizations in the public and private sectors accelerate digital transformation and AI adoption-resulting in a robust pipeline of over £4.4 billion in tech-related opportunities-there is risk that accelerating automation across industries could reduce demand for traditional, human-intensive outsourcing services, potentially creating future pressure on revenue and margins.
  
• Although Capita's heavy investment in AI, automation, and strategic partnerships with hyperscalers enables more efficient delivery and the creation of new, higher-margin services, the complexity and compliance burden of implementing these technologies-especially within sensitive public and regulated sectors-may lead to rising operational costs, limited scalability, and delayed realization of margin improvement.
  
• While strong public sector outsourcing trends, record Total Contract Value wins, and a diversified technology-enabled platform suggest future growth and revenue visibility, the company relies significantly on UK government budgets, which remain vulnerable to ongoing public sector austerity and shifting procurement strategies that could slow new contract awards or compress pricing over the long term.
  
• Even though Capita's ongoing restructuring and exit from non-core assets are reducing debt and streamlining its operations, legacy contract run-off and shrinking pipelines in traditional services could outpace the growth of new digital offerings, resulting in continued near-term topline pressure and limiting earnings visibility until transformational initiatives fully materialize.
  
• Despite early indications of improved employee engagement and strong operational KPIs (such as 81% win rates in Public Service and high renewal rates in Contact Centres), persistent underinvestment relative to leading global BPO peers, as well as talent shortages and wage inflation in the professional services sector, pose challenges to sustaining competitive advantage and expanding net margins in the years ahead.

Capita Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Capita compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Capita's revenue will decrease by 0.8% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 0.7% today to 3.5% in 3 years time.
• The bearish analysts expect earnings to reach £83.9 million (and earnings per share of £0.71) by about August 2028, up from £16.2 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 6.4x on those 2028 earnings, down from 16.6x today. This future PE is lower than the current PE for the GB Professional Services industry at 21.4x.
• Analysts expect the number of shares outstanding to grow by 0.79% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 12.9%, as per the Simply Wall St company report.

Capita Future Earnings Per Share Growth

Risks

• Structural decline in traditional Contact Centre revenues, with a 20% year-on-year drop and continued headwinds from offshoring and the telecoms vertical, signals that legacy services are shrinking faster than new digital solutions can offset, which negatively affects overall group revenue and earnings visibility.
  
• Persistent underperformance and losses in segments managed for value, notably Regulated Services which are expected to generate ongoing £20 million annual cash losses and experience a continued decline in revenue and margin, act as a drag on group profitability and limit improvement in net margins.
  
• Capita's transformation in the Contact Centres division remains four to five years behind industry leaders, which constrains margin recovery; weaker scale versus global peers and increased competition from digitally native BPO competitors could further compress margins and limit future cross-selling opportunities, reducing long-term earnings potential.
  
• Despite significant cost saving programs, year-to-date free cash outflow remains negative at £26 million and overall guidance anticipates £45 to £65 million net cash outflow for the full year, highlighting ongoing weak free cash flow and suggesting continued pressure on strategic flexibility and balance sheet strength.
  
• Ongoing regulatory scrutiny, such as the Ofgem investigation into Smart DCC and heightened compliance requirements in regulated industries, increases operational risk and potential for unforeseen costs, which may erode profitability and add volatility to future earnings.

Valuation

• The assumed bearish price target for Capita is £3.21, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Capita's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of £6.0, and the most bearish reporting a price target of just £3.21.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be £2.4 billion, earnings will come to £83.9 million, and it would be trading on a PE ratio of 6.4x, assuming you use a discount rate of 12.9%.
  
• Given the current share price of £2.36, the bearish analyst price target of £3.21 is 26.3% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.