Is it time to start buying these burned-out FTSE 250 stocks?

Roland Head reviews the investment case for two of last year’s biggest FTSE 250 (INDEXFTSE:MCX) fallers.

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There are few things I like more than buying shares of good companies at burned-out prices! The hard part is recognising the difference between a good company with temporary problems, and a company with fundamental weaknesses.

Today I’m looking at two of the top 10 fallers in the FTSE 350 over the last year. Both companies have lost at least 35% of their value in 12 months. Is either of them the type of stock I’d like to add to my portfolio?

I’m optimistic

Plastic component manufacturer Essentra (LSE: ESNT) has lost almost half of its value since March last year, thanks to a series of profit warnings.

In the firm’s latest results, Essentra’s new chief executive Paul Forman said that he believes the company’s 2016 problems were “predominantly self-inflicted” and are therefore fixable.

This week’s results were broadly in line with the guidance provided by the firm in January. Adjusted earnings from continuing operations fell by 31% to 29.2p per share, but the dividend was held unchanged at 20.7p.

These figures give Essentra a trailing P/E of 14.7 and a dividend yield of 4.8%. That seems an attractive valuation, especially as the group’s profits have historically been strongly supported by free cash flow.

However, Essentra isn’t without risk. Mr Forman warned today that sales and profits are expected to fall in 2017. This is due to the sale of the group’s Porous Technologies business, and to problems in its healthcare division, where sales and profits have fallen in recent months. Remedial action is underway, but we don’t know how long these issues will take to resolve.

Analysts are forecasting a 24% decline in adjusted earnings to 27p per share in 2017, with the dividend left unchanged at 20.7p. I think there’s still some risk of a dividend cut, but on balance I feel quite positive about the outlook for Essentra. I’ve added to the stock to my watch list as a potential recovery buy.

Is this market leader a smart buy?

Satellite communication provider Inmarsat (LSE: ISAT) is one of the global leaders in this sector.  Its services are widely used by shipping, governments and airlines. But this hasn’t corresponded to investment returns. The shares have lost 46% of their value since the end of 2015.

Profits have fallen over the last two years and are expected to fall again in 2017. The firm has complained of difficult market conditions, with many customers seeing budgetary pressures.

The problem is that market rates are falling for satellite services, but Inmarsat still has to invest heavily in maintaining and upgrading its satellites. The firm expects capital expenditure of between $500m and $600m in 2017 and 2018. That’s around 40% of forecast revenues.

A second risk is that debt levels are now quite high. Inmarsat’s last reported net debt was $1,793m. That’s 7.7 times the firm’s expected profits this year. In my view this is uncomfortably high, especially as this year’s dividend is not expected to be covered by earnings.

The latest consensus forecasts put Inmarsat on a 2017 forecast P/E of 15, with a prospective yield of 7.2%. In my view this valuation signals that the market expects a dividend cut. I agree with this view and believe the outlook for this stock remains uncertain.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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

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