Neil Woodford has vowed to stand by Capita following its latest profit shock, in a frank assessment on the challenges facing the outsourcing giant.
Capita has been a major factor behind Woodford's recent underperformance. Last week's profit warning delivered the just latest blow in a series of setbacks suffered by the UK's best known fund manager.
That was accompanied by news of a rights issue and a dividend suspension, as incoming chief executive Jonathan Lewis sought to kitchen sink a series of inherited issues.
This triggered a sharp sell-off, with its market capitalisation almost halving over a seven day stretch.
While admitting the latest Capita news has been 'unhelpful' to recent performance, Woodford said he is pleased by the firm's progress under Lewis, who assumed the role last October, after his predecessor left under a cloud of declining profits.
Woodford described the Lewis' hard break with business as usual as a 'complete reset' for Capita.
'[Lewis] has mapped out a clear new direction of travel for the business and it is one with which I completely agree,' he added.
'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.
Given the circumstances and the prospect of a long road ahead, Woodford said he was not surprised this was met by a massive fall in the share price from an already depressed level.
'[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,' Woodford said.
'This is the reality of what we have been writing about for some time now. Markets are being driven by momentum. Valuation is irrelevant – it simply does not matter in the stock market at the moment.'
For Woodford the only question that ultimately matters is what the company is worth. 'On that basis, it strikes me that a decision to sell Capita here is almost impossible to justify from a fundamentally-based perspective.'
He justified this view by drawing attention to some of the numbers behind Capita's fall. These include a fall in profit from £475 million at the start of 2016 to an expected £270 million to £300 million in 2018.
The share price has fallen from around £12 to 175p over this period.
'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,' Woodford said.
'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.'
Woodford also noted that collapse of Carillion has 'catalysed' the whole outsourcing sector to rebase its relationship with the government, which also recognises the need for change, to reflect a fairer balance between risk and reward.
'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,' Woodford 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.'
Talking more broadly about his tough spell, Woodford warned that while the market continued to behave in a way he perceives as irrational, he is likely to struggle.
'While 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.
'I will underperform in such market conditions as I have done before. 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.'
Woodford returned just 0.5 on his flagship LF Woodford Equity Income fund in 2016 versus a peer group average of 10.4%.
Over three years the fund has returned 20.5% versus the peer group's 26.6%.