Avoid Catching The Falling Knife: Ocado Group Plc, Lonmin Plc & EnQuest Plc

Will Ocado Group Plc (LON: OCDO), Lonmin Plc (LON: LMI) and EnQuest Plc (LON: ENQ) prove to be bargain buys or value traps?

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Bargain-seeking investors will likely have at least one of Lonmin (LSE: LMI), Ocado Group (LSE: OCDO) or EnQuest (LSE: ENQ) on their shortlists after shares of each plummeted over the past year. However, there’s a fine line between value plays and value traps and these three companies may fall on the wrong side.

South African platinum producer Lonmin’s fall from grace has been sudden and severe. The shares are down from over £20 this time last year to under 80p now. While platinum prices have come down 30% over this time, this dramatic backslide is mainly to due to larger structural issues. The company’s mines are costly, labour prices have risen dramatically and the company has neglected to fix its balance sheet for far too long.

A rights issue in November, billed by management as critical to the continued survival of the company, was its third since 2009. The $400m shareholders were tapped for has staved off the inevitable for the time being but unless platinum prices rebound quickly Lonmin will be back at square one. $150m in net debt remains, while the company only holds $69m in cash and has access to $203m of credit lines. If free cash flow remains as poor as it was in 2015, when it was negative to the tune of $167m, the company will be back to debt markets or shareholders cap in hand by next year. Given these major structural issues and poor outlook for platinum prices, I would classify Lonmin firmly in the ‘value trap’ category.

Elusive profits

Ocado may have increased sales by double-digits for 13 consecutive quarters, but nearly 20% of the online grocer’s shares are short positions betting against the company. The reason for this is that the company has taken the Amazon approach of gaining market share at all costs rather than profitability. Analysts are unconvinced that Ocado will be able to flex as much pricing power as the American retail juggernaut when it does come time to actually bring in significant profits.

Management has taken pains to eke out small profits in the past two quarters, but I share the City’s doubts that margins can be hiked considerably in the future. The grocery industry as a whole is battling falling profits and traditional grocers such as Tesco and WM Morrison have increased their online presence to juice market share. These competitors and Amazon Pantry will likely lead to price wars and shrinking profits in the online grocery space, just as they have in the traditional grocery business.

Mounting losses

Independent oil producer EnQuest faces many of the problems emblematic of North Sea oil companies: staggering debt levels, high cost of production assets, and little diversification. Net debt at the end of 2015 clocked in at a full $1.5bn, higher than revenue in any of the past five years. Management has slashed costs enough to bring operating costs per barrel down to $26 to $28/bbl. However, crude prices in the mid-$30s mean that EnQuest is making little headway in funding capex or paying-down debt. With net gearing at 62% and earnings expected to be even further in the red next year, I don’t see EnQuest shares heading upwards anytime soon.

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.

Ian Pierce has no position in any shares mentioned. 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.

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