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Is Safestyle plc a falling knife to catch after dropping 10% today?

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Shares in small-cap window and door replacement specialist Safestyle (LSE: SFE) plummeted over 10% in early trading this morning as the company released a fairly gloomy half-year trading update.

Here’s why I think the market has overreacted.

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Profit warning

Granted, things could be better. While order intake has remained similar to that announced at its last trading update in May, the trend from week to week in Q2 has been “more volatile” than that experienced “for a long time“, according to the company.  

Following on from May’s AGM statement (which also prompted a fall in its share price), Safestyle now believes it will report “marginal revenue growth” and “reduced profits” for the first half of 2017. Sensing that consumer confidence will continue to weaken, the company also revised its full-year outlook by stating that profits were likely to be “broadly in line” with those achieved in 2016.

While today’s update is concerning, it’s not completely unexpected given the prevailing economic uncertainty. It’s also apparent that Safestyle continues to outperform its competitors based on recent statistics that point to a market decline of over 10% in terms of volume. Should the housing market suffer as economic pessimism grows, I believe Safestyle could be in a solid position as more homeowners consider making improvements to their existing properties rather than moving on.

In addition to the above, it appears to be the epitome of sound financial management. Cash flow remains strong and, despite considerable investment in new facilities, the company’s net cash position of almost £18m at the end of June should act as a decent buffer during tough times. Today’s announcement that management had already taken steps to reduce operating costs in H2 should also comfort those already invested. 

While the shares could certainly fall lower if sentiment worsens over the next few months, I think Safestyle warrants consideration once the dust has settled. Already trading at just 11 times earnings and offering (for now) a yield approaching 4.7%, I suspect this could be one knife worth catching.

A safer bet?

Of course, there are plenty of other options available to investors in the small-cap universe. Another reporting to the market this morning was email and marketing automation software provider dotDigital (LSE: DOTD).

In complete contrast to Safestyle, overall revenues at the Croydon-based company rose by 19% (to roughly £32m) over the year to the end of June. Revenue growth outside the UK was particularly strong (up 48%), with the Asia-Pacific market registering the strongest growth (up 156% to £700,000).  

With 81% of total group revenues now recurring and the average spend per client increasing by 24% to about £715m per month, I can’t see demand for the £210m cap’s services drying up anytime soon. Indeed, having completed his first full year as CEO, Milan Patel reflected that the “building blocks” were “now in place” for the company to perform strongly over the next year

Trading at 26 times forward earnings, shares in dotDigital look fully valued right now. Even so, I’m still attracted to the stock. Bear in mind that this company has shown a real ability to generate consistently high returns on the money it invests. At around 25%, operating margins are seriously good and dotDigital has the sort of free cashflow and balance sheet that would turn many companies green with envy.

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Paul Summers has no position in any shares mentioned. The Motley Fool UK has recommended Safestyle UK. 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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