Is Essentra plc’s 10% slump on profit warning a buying opportunity?

Could Essentra plc (LON: ESNT) recover after today’s disappointing news?

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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.

Components and solutions specialist Essentra (LSE: ESNT) has reported a profit warning, sending its shares down by as much as 10%. Clearly, this is hugely disappointing for the company’s investors and means there could be a period of uncertainty in the near term. However, does it also signal a buying opportunity, with a lower valuation providing additional scope for capital gains?

A tough period

The performance of the company’s Health & Personal Care Packaging division has been below expectations for the 2016 financial year. Revenue and profitability have declined significantly as a result of continuing operational issues in the last two months of the year in particular. This means that while trading in the Component Solutions and Filtration Product divisions has been in line with expectations, the company’s overall profitability will be at, or modestly below, the bottom end of previous guidance. As such, adjusted operating profit will be £137m or lower.

Potential improvement?

Perhaps the most disappointing aspect of today’s trading update is the fact that Essentra believes the situation won’t improve in the short run. Although there will be a specific focus on the division by the CEO and other senior managers, the 2017 financial year could see more disappointment. Therefore, it would be unsurprising for the company’s share price to fall further in the short run.

Beyond that, there’s upside potential. Essentra trades on a price-to-earnings (P/E) ratio of just 11.8, which appears to represent good value for money. In the current year it’s forecast to post a fall in earnings of 5%, but in 2018 the company is due to reverse this with growth of 10%. This puts it on a price-to-earnings growth (PEG) ratio of 1.2, which provides further evidence of its attractive valuation. And with a yield of 4.9% from a dividend which is covered 1.7 times by profit, it could be a sound buy for income investors too.

A better option?

However, within the support services sector there may be a better option. Plumbing and heating products specialist Wolseley (LSE: WOS) is expected to record a rise in its bottom line of 18% this year, followed by further growth of 10% next year. This has the potential to improve investor sentiment in the stock and since much of the company’s business is focused on North America, it could benefit from weaker sterling to a greater extent than many of its sector peers.

Although Wolseley has a PEG ratio of 1.6, it offers a lower-risk profile than Essentra. Its outlook is relatively robust and its shares are unlikely to be as volatile. Furthermore, it has dividend growth potential, with its shareholder payouts covered 2.6 times by profit. As such, its 2.3% yield could rise sharply over the medium term.

While Essentra may be worth buying for the long run, its shares are likely to be volatile in the coming days and weeks. Therefore, Wolseley seems to be the better buy, with its more robust and consistent growth outlook providing a superior risk/reward ratio at the present time.

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 considered so you should consider taking independent financial advice.

Peter Stephens 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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