Why these ‘bargain’ stocks could seriously harm your wealth

Roland Head argues that investors need to be wary of the risks facing these two companies.

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Shares of South African platinum miner Lonmin (LSE: LMI) fell by nearly 5% on Monday morning, after the firm reported an underlying operating loss of $35m for the first half of the year.

Today I’ll explain why I still don’t think that Lonmin stock is cheap enough to buy. I’ll also take a look at a second company which could prove to be a value trap for investors.

Costs are still too high

Lonmin’s share price has fallen by 45% over the last year, as concerns about the group’s future grow. At about 110p, the stock now trades at just 25% of its tangible net asset value of 434p. This might look like a bargain, but there’s a good reason for the market’s caution. The firm hasn’t made a profit since 2013, and it could run out of cash (again) in the next few years.

Revenue fell by 6% to $486m during the first half, despite the US dollar price of platinum group metals (PGM) rising by 8% per ounce. The problem for Lonmin is that as PGM prices have risen, the South African rand has gained strength against the dollar. The effect of this has been to cancel out any potential gains from higher prices.

Production losses earlier this year and the stronger rand have forced it to increase its full-year cost forecasts. The miner now expects unit costs to range from R11,300 to R11,800 per platinum group metal (PGM) ounce this year, up from R10,800 to R11,300 previously.

Given that the group’s average sale price was R10,852 per PGM ounce during the first half, Lonmin seems likely to report a significant operating loss this year. This could be a problem as its net cash balance was just $75m at the end of March, down from $173m at the end of September.

In my view, it’s not clear whether it will be able to return to profit quickly enough to avoid running out of cash. For this reason, I believe this stock remains one to avoid.

A 9% dividend yield?

Interiors and fashion retailer Laura Ashley Holdings (LSE: ALY) remains profitable and pays a generous dividend. But the group faces an uncertain outlook.

Like-for-like retail sales fell by 3.5% during the first half. This contributed to a 30% slump in pre-tax profit, which fell to £7.8m. The interim dividend was cut by 50% to 0.5p.

Analysts expect full-year earnings to fall by 50% to 1.2p per share this year, putting the stock on a forecast P/E of 11. This suggests to me that 2017 forecasts for a total dividend of 1.25p per share carry some risk. This payout would give a massive dividend yield of 9.3%, but would not be covered by earnings. That’s a classic recipe for a dividend cut, especially as Laura Ashley’s net debt rose from £3.7m to £25.1m last year.

I could be wrong. Management may yet pull off a turnaround and save the dividend. But as things stand, I think there’s a real risk that Laura Ashley could be a value trap — a stock that’s cheap for a good reason.

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. 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.

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