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Should you catch this falling knife after another NCC Group plc profit warning?

Image: The Motley Fool Editorial.

Does cyber security group NCC Group (LSE: NCC) offer value after today’s profit warning, or are further falls likely? The company’s shares have now fallen by 36% in 2016, but adjusted profits are still expected to rise during the current financial year.

In this article I’ll take a closer look at NCC. I’ll also consider the investment case for a stock whose shares have been hit by industry news, despite management guidance that “no material impact” is likely.

Sales up by 35%

Today’s profit warning from NCC formed part of its first-half trading update. The news initially seemed good. Group revenues rose by 35% to £125.8m during the first half of the year, apparently putting the group on track to hit full-year forecasts of £245.8m.

However, NCC also updated shareholders on the expected impact of the contract losses reported in October, when the shares fell by 35% in one day. NCC expects full-year adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) to be between £45.5m and £47.5m. That represents an increase of up to 5% on last year, but investors had been expecting much larger gains.

A second risk is that the group’s poor performance during the first half means that more than half (54%) of profit is expected to be earned during the second half. Companies that say profits will be weighted to the second half often end up issuing another profit warning later in the year.

I’m not convinced that NCC shares are cheap enough to be a genuine bargain. The group’s profit margins fell last year, and the outlook for this year remains uncertain.

Today’s fall suggests that the market now expects earnings to be below consensus forecasts of 11.9p per share in 2016/17. Even if NCC does hit this forecast, the firm’s shares still trade on a forecast P/E of 16, with a yield of just 2.5%.

I’d like to see evidence that performance has stabilised before committing any cash to this company.

This could be a better buy

Shares of software group Playtech (LSE: PTEC) have fallen by 13% since the end of November. One of the main reasons for this decline is that the group provides software for online spread betting firms. New proposals from the FCA to tighten the regulation of this sector seem likely to reduce profit margins.

Investors are concerned that demand for Playtech’s software could fall. But management says the proposals “are not expected to have a material impact”. If correct, then the shares could be attractively priced at the moment. The stock currently trades on a forecast P/E of 14 for the current year, falling to a P/E of 11.5 in 2017.

Playtech also has income potential, thanks to strong free cash flow. In addition to a forecast ordinary dividend yield of about 3.3%, it has just paid a special dividend of €0.46 per share, and commenced a €50m share buyback programme.

Current forecasts suggest adjusted earnings per share could rise by 23% in 2017. The group’s recent growth has been strong, and may continue. However, investors need to remember that the two main sectors in which Playtech operates — online gambling and financial betting — are at constant risk of regulatory disruption.

As things stand, I’d rate its as a hold.

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Roland Head has no position in any shares mentioned. The Motley Fool UK owns shares of NCC. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.