2 high-risk stocks I’d probably avoid

Roland Head explains why these tempting businesses could be costly investments.

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Premier Foods (LSE: PFD) owns well-known brands like OXO and Mr Kipling. It ought to be a safe, boring stock with a reliable dividend. But as shareholders know, the reality could hardly be more different.

The group’s underlying sales fell by 1.4% to £790.5m last year, pushing adjusted pre-tax profit down by 11.8% to £74.2m. Adjusted earnings per share for the year ending 1 April 2017 fell by 12.2% to 7.2p. The group said the fall was the result of the rising price of commodities such as sugar and cocoa, along with the weaker pound.

Premier’s biggest problem is debt. The firm only managed to reduce its net debt by £11m to £523.2m last year. This means that it s still 3.9 times earnings before interest, tax, depreciation and amortisation (EBITDA). That’s uncomfortably high.

Most companies target a net debt-to-EBITDA ratio of no more than two times. Premier Foods hopes to bring its ratio below three times “in the next three to four years”. To help this process, a £20m cost-cutting programme is planned for the next two years.

Many shareholders will think that the firm’s board should have accepted last April’s possible offer of 65p per share from US group McCormick & Company. At 42p, the firm’s shares are worth 35% less than McCormick’s bid. It’s not obvious to me why the board thought the offer was too low.

Premier stock has a forecast P/E of six for 2017/18. That may seem tempting, but I believe the group’s debt burden means that the share price is likely to remain under pressure for the foreseeable future. I’d look elsewhere.

Does this sky-high price make sense?

AIM-listed luxury handbag designer Mulberry Group (LSE: MUL) doesn’t have debt worries — the group had net cash of £11.3m at the end of September. But this financial security comes at a steep price for shareholders.

Mulberry’s annual profits peaked at £25.3m in 2012. Performance since then has been disappointing. The group reported a loss of £1.4m in 2015 and is expected to report a full-year profit for the year which ended on 31 March.

My concern is that a far greater recovery already appears to have been factored-into Mulberry’s share price. At 1,086p, the stock trades on a forecast P/E of 130 for the year just ended, falling to a P/E of 100 for the current year.

In my view, the only way this valuation might make sense is if Mulberry starts to deliver strong sales growth and rising margins. It’s not clear to me if this is likely.

Although Mulberry does have a new creative director — ex-Louis Vuitton designer Johnny Coca — the group’s sales have yet to break through the high of £168.5m seen in 2012. Profit margins also have a long way to go to reach previous highs. The company reported an operating margin of 3.9% last year, down from 21% in 2012.

This stock already seems to be priced for perfection. Although Mulberry’s future performance might justify this valuation, I’m afraid that any slight disappointment could cause the shares to crash. On that basis, I’m not interested at current levels.

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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