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Why I see 40% upside in this turnaround stock in 2017

Image: Carpetright: Fair use

Europe’s leading specialist carpets and flooring retailer Carpetright (LSE: CPR) has enjoyed a nice little uptick in its share price since the start of the year, gaining 42% since its New Year’s Eve closing price of 151p. I think shareholders deserve a little joy after seeing the value of their holdings slump to near-record lows at the end of 2016, following a long and painful decline from the dizzy heights of 1,346p achieved a decade ago.

Turnaround potential

It’s true that Carpetright no longer enjoys the same levels of sales revenue it did 10 years ago, and underlying earnings are just a fraction of what they were during those heady days, but I think the business is showing encouraging signs of turnaround potential.

In the last financial year the Essex-based retailer almost doubled its pre-tax profits to £12.8m, from £6.6m the year before, which in itself was a marked improvement from the disastrous £7.2m pre-tax loss it suffered for fiscal 2014. All the while underlying earnings have grown from just 4.7p per share in FY 2014 to a much healthier-looking 19.3p for the last completed financial year.

New brand identity

In its recent third quarter trading update the small-cap retailer announced a return to quarterly like-for-like sales growth in the UK, with a 1.9% rise in sales for the 13 weeks to the end of January. What is most encouraging is that like-for-like sales are up by an impressive 6.8% for the first four weeks in January, reinforcing my confidence that some kind of recovery is under way.

What’s also encouraging is that newly refurbished stores, which come garnished with Carpetright’s new brand identity, continue to outperform the un-invested estate, leading management to accelerate its refurbishment plan. The company is now trying to achieve a target of 150 refurbished stores by the end of April, representing around a third of the entire UK estate.

Analysts are forecasting broadly flat sales revenue over the medium term, but pre-tax profits are expected to climb significantly from £12.8m to £19.95m over the next three years. After a 40% share price slump in just 12 months, the shares are trading at a modest 13 times earnings for the current year, falling to just 10 by April 2019. I see Carpetright as a great recovery play with plenty of upside potential.

Controversy

Another famous retailer whose share price has been battered in recent years is the UK’s leading sports retailer Sports Direct (LSE: SPD). The share price has been under pressure over the past couple of years amid controversy surrounding the treatment of its warehouse staff as well as numerous profit warnings. The Mansfield-based retailer has seen the value of its shares fall by a fifth over the past year, with the share price now languishing around five-year lows.

But unlike Carpetright I don’t see the shares bouncing back anytime soon. Underlying pre-tax profits crashed 57% in the first half of the current financial year, and the City is expecting the decline in earnings to continue into next year. Despite the massive share price slump, Sports Direct’s shares are still not cheap, trading at 19 times forward earnings for the year to April. I would wait until the outlook improves.

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Bilaal Mohamed has no position in any shares mentioned. The Motley Fool UK has recommended Sports Direct International. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.