2 stocks I plan to avoid in March

Roland Head explains why he’s steering clear of two of this week’s big risers.

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Wednesday’s results from satellite broadband group Inmarsat (LSE: ISAT) showed that despite sales rising ahead of expectations, the group’s profits fell sharply last year.

Its shares rose by 6.5% following the publication of these figures. But I remain concerned about the outlook for shareholders. In this piece I’ll explain why I’m worried. I’ll also highlight another stock where I think turnaround celebrations are premature.

This high flyer has bottom line problems

Inmarsat’s revenue rose by 4.3% to $1,329m last year, beating forecasts of $1,307m. The group’s after-tax profits fell by 13.7% to $243.3m, slightly ahead of forecasts of $236.3m.

This company is a market leader in the satellite broadband sector, serving airlines, governments and the global shipping industry. The quality of these operations doesn’t concern me.

What does worry me is Inmarsat’s balance sheet, spending plans and valuation. Profits fell last year because financing costs rose from $90.2m to $123.4m. To put that in context, the company paid its lenders almost $1 from every $10 of sales in 2016.

Although net debt actually fell by $91m last year, the firm still has net borrowings of $1,894.8m. That’s equivalent to 2.4 times earnings before interest, tax, depreciation and amortisation (EBITDA). That seems high to me, especially as capital expenditure is expected to rise from $412m in 2016 to $500m-$600m in 2017 and 2018.

Free cash flow over the last two years has averaged about $300m. So unless sales and profits rise sharply this year, I estimate that perhaps $400m of additional borrowing may be required to bridge the gap between operating cash flow and expenditure.

In my view, the forecast dividend yield of 6.1% is vulnerable to a cut. I’d also argue that the forecast P/E of 18 offers very little downside protection for shareholders.

Inmarsat is a quality business. But I don’t think the equity is attractive at the moment.

These shares look overcooked to me

Frankie & Benny’s owner Restaurant Group (LSE: RTN) gained 8.5% on Wednesday morning, after new chief executive Andy McCue laid out his turnaround plans for the firm. Investors were not deterred by news that adjusted pre-tax profit fell 11.2% to £77.1m last year. Nor were they concerned by a £116.7m restructuring charge that pushed the group to a full-year loss of £39.5m.

Since taking charge last year, Mr McCue has found that most of the firm’s main brands are suffering thanks to pricing hikes and unpopular menu changes. Reversing these mistakes has helped, but won’t be enough to return the group to growth.

Plans are in place to rejuvenate its main brands. The good news is that the firm’s balance sheet and cash flow remain strong. Both capital expenditure and the group’s dividend were fully covered by free cash flow last year, leaving net debt unchanged at just £28m.

The group’s pubs and concessions business — such as airport eateries — are also trading well.

Restaurant Group’s financial strength makes me more likely to invest here than in Inmarsat.

I certainly plan to keep an eye on this stock as a potential turnaround buy. But with the shares now trading on a forecast P/E of 16 and the ongoing risk of a dividend cut, I’m going to hold back for a little longer.

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 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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