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An incredibly cheap growth stock I won’t be gambling on

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Not all shares trading on low valuations are quite the bargains they first appear to be. New arrival on the London Stock Exchange Jackpotjoy (LSE: JPJ) is, for me, an example of this. That may come as a surprise based on the numbers contained in this morning’s trading update, so let’s take a look at these first.

Positive reaction

Today, the largest online bingo-led operator in the world announced results for the three months to the end of March. Gaming revenue rose a very respectable 11% to £71.4m. Of its three segments, Jackpotjoy — responsible for 71% of group revenue — achieved growth of 14% thanks to new product launches and mobile growth. Bringing in a fifth of revenue, online casino brand Vera&John showed growth of 13%. Revenue at bingo brand Mandalay fell 14% however, as a result of changes in promotional spend relating to the point-of-consumption tax (due to take effect in August).

Overall, adjusted EBITDA rose 4% to just over £29m compared to the same period last year with average active customers growing 15% to almost 240,000 with each spending an average of £87 (up by 2%). CEO Andrew McIver confirmed that group trading continued to be in line with management expectations and that Jackpotjoy’s board remains confident of the company being able to grow “in line with the market” over the course of 2017.

All in all, quite a positive update then. The market also appeared to like what it heard with shares rising over 2% at the open. So why — given that the shares currently trade on a paltry six times earnings for 2017 and a price/earnings to growth (PEG) ratio of just 0.52 — aren’t I a buyer?

Cheap for a reason

A quick glance at the company’s balance sheet should be sufficient for understanding my concerns about the £420m cap. At the end of March, Jackpotjoy had adjusted net debt of a smidgen over £407m — barely different from the figure at the end of 2016 (£408m). Even with gross cash of £112m at the end of the quarter and predicted net profits of £124m in 2017, a pile this high is a huge red flag for me.

The company’s relatively high level of debt also goes some way to explaining why Jackpotjoy is very unlikely to offer anything in the way of dividends for the foreseeable future. That sort of thing might not bother growth-focused investors but anyone wanting some kind of compensation for entrusting his/her capital to a company operating in a hyper-competitive market may wish to think twice.

A far better alternative, in my opinion, would be sports betting and gaming company GVC Holdings (LSE: GVC). While more expensive at 16 times 2017 earnings, this drops to a little under 13 in 2018 based on a predicted 24% rise in earnings per share in 2018. What’s more, the Isle of Man-based, £2.3bn cap’s shares currently boast a PEG ratio of just 0.67, implying that prospective investors will be getting just as much bang for their buck as they would from Jackpotjoy.

In stark contrast to the small-cap, GVC’s net debt stood at £49m at the end of 2016. With net profit expected to hit almost £175m this year, I’d be far more comfortable owning a slice of this company. A healthily-covered dividend yield of 3.5%, forecast to rise by 15% in 2018, makes the investment case even sweeter. 

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Paul Summers has no position in any shares mentioned. The Motley Fool UK has recommended GVC Holdings. 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.