Investing.com -- Capita plc in a note dated Monday has received an upgrade from RBC Capital Markets, with analysts now assigning an "outperform" rating and raising the target price to 20p from 17p.

The upgrade reflects growing confidence in Capita’s financial trajectory, boosted by an improving balance sheet and progress toward positive free cash flow.

RBC analysts noted, "We increase our target to 20p from 17p, upgrade to Outperform from Sector Perform, believe risk reward is now in favour and note we are at last getting closer to the point Capita becomes FCF positive."

Capita’s full-year results aligned with expectations, with operational stability and improving contract performance.

The company continues to execute on its strategic priorities, including increased technology adoption, improved contract delivery, and cost-saving initiatives.

RBC highlighted that Capita has already achieved £140 million in cost savings out of a targeted £250 million.

Despite these operational improvements, growth remains challenging, particularly given the political uncertainty ahead of the UK general election.

The revenue outlook remains mixed. While Capita’s renewal win rate increased to 92%, and its contract pipeline grew 8% to £11.1 billion, immediate revenue growth is expected to remain subdued.

RBC pointed out that nearly half of the pipeline consists of opportunities with a significant AI-driven component, which could provide long-term upside.

Following these developments, RBC made modest forecast adjustments, lowering its 2025 and 2026 pre-tax profit before amortization estimates by 6% and 4% respectively, primarily due to higher interest costs from new financing.

A key factor in RBC’s valuation reassessment was the greater transparency around Capita’s Experience division, which was broken down into its three core components: Contact Centre, Pension Solutions, and Regulated Services. The disclosure revealed that the Pension Solutions business is more profitable than previously thought, while the Contact Centre division is underperforming.

RBC analysts noted, "Pensions Solutions makes much more money than we had assumed (c£190m revenues and a margin of c.16%), whilst the Contact Centre business makes much less (£650m revenues and a £6m loss)."

This shift positively impacts Capita’s sum-of-the-parts valuation, as the Pension Solutions business commands a higher earnings multiple than the Contact Centre unit, which faces challenges from AI-driven automation.

One of Capita’s most significant hurdles has been its inability to generate free cash flow (FCF) consistently.

However, RBC believes the company is nearing a turning point. "Lack of FCF generation has been THE major issue at CPI. However, with restructuring costs expected to materially reduce, pension deficit payments coming to an end, deferred income becoming less of a drag and with EBITDA moving up, we expect CPI to finally turn FCF positive for FY26E."

This marks a crucial shift for investors who have been wary of Capita’s financial sustainability. RBC’s revised valuation implies an attractive FCF yield of 7.5% in 2026, rising to 14% in 2027.

RBC has taken a cautious approach to its valuation, assigning a 40% discount to peers for Capita’s Public Services division, reflecting lower growth and weaker cash conversion.

The Pension Solutions business was valued at eight times EBITA, given its strong margins, while the Contact Centre unit was assigned a valuation of 0.2 times sales, considering its ongoing losses and AI-related risks.

RBC stated, "We have taken a very conservative view on the valuations we apply to the businesses, but even so our SOP valuation moves up to 20p, which would equate to a 26E FCF Yield of 7.5% and 27E of 14.0%."

Despite the upgrade, risks remain. RBC cautioned that Capita must successfully convert its pipeline into revenue, maintain contract renewal momentum, and navigate government contract cycles. If these factors materialize positively, the company’s outlook could improve further.