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2 beaten-down shares with turnaround potential

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Here are two beaten-down shares that I believe have big turnaround prospects in 2017.

Tough year

It’s been a tough year for BT (LSE: BT.A) shareholders. Despite a strong performance from the FTSE 100, shares in the telecoms company have fallen more than 20% over the past 52 weeks. BT shares have been in stuck in a downtrend for more than a year, as investors have been spooked by the company’s widening pension deficit and the possible legal separation of its Openreach network operations.

However, I feel that these fears may be overdone and I wouldn’t be surprised to see BT shares make up lost ground this year. That’s because underlying fundamentals remain strong as its investment in fibre broadband services begins to pay off in terms of profitability and free cash flow generation.

Management is also making good on the promise to deliver revenue and cost synergies from the acquisition of mobile operator EE, which could greatly enhance BT’s competitive position and customer profitability. And in spite of despite regulatory uncertainty, the possibility of a positive outcome from Ofcom’s ruling on BT’s Openreach division could greatly renew investor confidence in the company’s near-term outlook and give its shares a much needed boost.

Attractively priced

At a forward price-to-earnings ratio of 12.8, BT shares are attractively priced in today’s market, and especially so when compared to sector peers Vodafone and Sky, which have forward P/Es of 37.1 and 17.3, respectively.

What’s more, BT’s dividend prospects appear to be in good shape even as its pension deficit approaches £10bn. That’s because free cash flow is set to exceed £3.1bn this year, and £3.6bn next, which would give the company ample room to increase its pension contributions and deliver further dividend growth.

The shares may currently yield just 3.6%, but for 2017 and 2018, city analysts expect BT’s yield would rise to 4.0% and 4.4%, respectively.

Muted reaction

Marks and Spencer‘s (LSE: MKS) general merchandise sales have been struggling for a number of years, but a turnaround seems to be in sight. Like-for-like sales for its clothing and homeware products smashed market expectations by rising 2.3% during the Christmas shopping period — the first piece of good news from its general merchandise business in seven years.

However, investors remain unnerved on its outlook and the muted share price reaction on this latest piece of good news reflects this mood. Concerns that consumer spending may be about to wane as higher inflation is set to hurt real household incomes this year remains high on the agenda, but investors are also concerned that M&S still has a long way to go before sales return to steady year-on-year growth.

Upside potential

With M&S now trading at 12.8 times expected 2015/6 earnings, there’s plenty of upside potential.

Its sector peers trade on an average of 15.1 times earnings, while the FTSE 100’s average forward P/E is 13.6. What’s more, shares in M&S currently yield 5.6%, which is significantly above the sector’s peer average of 4.4% and the FTSE 100’s average yield of 3.2%.

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Jack Tang has a position in Marks and Spencer Group plc. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.