The one FTSE 250 stock I’d sell ASAP

There are so many reasons why I’d ditch this FTSE 250 (INDEXFTSE:UKX) toxic stock today.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

I’m so concerned about the risks facing investors in Mitie (LSE: MTO) that if I owned the stock, I’d sell it today.

Imploding balance sheet

Ruby McGregor-Smith became Mitie’s CEO at the end of March 2007 and formed a formidable executive partnership with finance director Suzanne Baxter.

The table below shows some features of the balance sheet at the time Ms McGregor-Smith inherited it and at the last two reporting dates.

  31 Mar 2007 31 Mar 2016 30 Sep 2016
Net assets (£m) 204 415 225
Intangible assets [of which goodwill] (£m) 158 [148] 532 [465] 421 [359]
Goodwill as % of net assets 73% 112% 160%
Net asset value (NAV) per share 65p 115p 63p
Net cash/(debt) (£m) 6 (178) (232)
Gearing 0% 43% 103%

As you can see, net assets grew impressively from £204m to £415m between March 2007 and March 2016. However, this was driven by a large increase in intangible assets — mainly goodwill from Mitie’s multiple acquisitions.

At 31 March 2016, the group’s healthcare division accounted for £107m of the total goodwill of £465m. Just six months later — in Ms McGregor-Smith’s last results before stepping down — the  healthcare division goodwill was entirely written-off. Her successor, Phil Bentley, sold the business for £2.

The write-off and an increase in borrowings were largely responsible for net assets plunging between March and September 2016. In fact, NAV per share of 63p was lower when Ms McGregor-Smith departed than when she arrived (65p). And the balance sheet was considerably weaker: goodwill represented 160% of net assets compared with 73% in 2007, while net debt had ballooned to £232m (103% gearing) from net cash 10 years ago.

I suspect there’ll be further goodwill writedowns when Mitie releases its annual results later this month, with new boss Mr Bentley likely to do some serious ‘kitchen-sinking’. And I wouldn’t be surprised if there’s a discounted fundraising at some point — well below the current share price of 211p — to shore up the balance sheet.

It gets worse

Mitie (and its peers) have often been accused of opaque and possibly aggressive accounting, with much justification, in my opinion. There are a number of things in Mitie’s accounts that concern me, including the level of accrued income. This is revenue that has been recognised but not billed.

The table below shows accrued income as a percentage of revenue for Mitie and its peers.

  2013 2014 2015 2016 H1 2017
Capita 8.1 9.3 9.4 8.6
Interserve 4.7 4.9 4.6 5.0
Mitie 8.3 8.5 10.6 12.8
Serco 8.0 6.0 7.1 7.6

Mitie’s accrued income as a percentage of its revenue has been increasing every year and, worryingly, is dramatically higher than its peers. Another disconcerting aspect to this is that at various points in time the four companies switched from reporting ‘prepayments and accrued income’ in one line to reporting them in separate lines.

Capita, Serco and Interserve did this in 2010, 2014 and 2015, respectively. Their prior year comparative numbers are consistent with those in their previous annual reports. However, in Mitie’s case (2015) the numbers don’t tally. There’s a £42.2m discrepancy. The company gives no explanation for it. It takes a nerdish comparison and reworking of receivables in the two annual reports to figure out that in 2015 Mitie retrospectively reclassified at least £13.3m and probably £42.2m as accrued income in 2014.

I’m expecting a writedown of accrued income in the upcoming results. And other nasties. Finance director Ms Baxter has followed Ms McGregor-Smith out of the door and new boss Mr Bentley has brought in KPMG to lead an independent review of the accounts.

These are just some of the reasons why I rate the shares a sell.

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.

G A Chester has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Young mixed-race couple sat on the beach looking out over the sea
Investing Articles

I’d put £20K in an ISA now to target a £1,900 monthly second income in future!

Christopher Ruane shares why he thinks a long-term approach to investing and careful selection of shares could help him build…

Read more »

Mature couple at the beach
Investing Articles

6 stocks that Fools have been buying!

Our Foolish freelancers are putting their money where their mouths are and buying these stocks in recent weeks.

Read more »

Black woman using loudspeaker to be heard
Investing Articles

I was right about the Barclays share price! Here’s what I think happens next

Jon Smith explains why he still feels the Barclays share price is undervalued and flags up why updates on its…

Read more »

Investing Articles

Where I’d start investing £8,000 in April 2024

Writer Ben McPoland highlights two areas of the stock market that he would target if he were to start investing…

Read more »

View of Tower Bridge in Autumn
Investing Articles

Ahead of the ISA deadline, here are 3 FTSE 100 stocks I’d consider

Jon Smith notes down some FTSE 100 stocks in sectors ranging from property to retail that he thinks could offer…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

Why I think Rolls-Royce shares will pay a dividend in 2024

Stephen Wright thinks Rolls-Royce shares are about to pay a dividend again. But he isn’t convinced this is something investors…

Read more »

Investing Articles

1 of the best UK shares to consider buying in April

Higher gold prices and a falling share price have put this FTSE 250 stock on Stephen Wright's list of UK…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

The market is wrong about this FTSE 250 stock. I’m buying it in April

Stephen Wright thinks investors should look past a 49% decline in earnings per share and consider investing in a FTSE…

Read more »