Is this small-cap stock a falling knife to catch after dropping 15% today?

Paul Summers considers whether today’s share price fall of this market minnow is an opportunity for brave investors.

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Things really have been dire for holders of tool and equipment supplier HSS Hire (LSE: HSS) lately. Since coming close to breaching the £1 mark last November, the shares have almost halved in value as concerns over Brexit have hit the construction industry. 

Unfortunately, today’s interim results have simply poured more petrol on the fire. Over the 26-week period to start of July, revenue at the small-cap fell 3.4% to £160.5m. As a result of “substantial changes” to its operating model, the company booked an adjusted pre-tax loss of £14.2m.

While reflecting that new sales initiatives and cost savings had allowed HSS to return to profitability in June and should lead to a stronger performance in H2, new CEO Steve Ashmore stated that the rate of recovery had been “materially slower than originally expected“. An update on a detailed strategic review is expected in November but it’s fair to assume that a reversal of HSS Hire’s fortunes is going to take a lot longer than first thought.  

Falling 25% in early trading, shares have recovered somewhat. So, is this a knife worth catching? Not in my view.

Aside from today’s awful set of figures, HSS’s extraordinarily high debt burden and inability to consistently turn revenue into solid profits make it a stock for only the most risk-tolerant, patient investors. Free cashflow is unpredictable at best and there’s no dividend to speak of. While a turnaround isn’t beyond the realms of possibility and some kind of bounce may be experienced as traders speculate that today’s reaction has been overdone, I simply can’t see a recovery being anything but long and painful.

Time to take profits?

Also releasing interim numbers this morning was budget gym operator The Gym Group (LSE: GYM). While its results are far better than those presented by HSS, Gym is another stock I’d sell today if for completely different reasons.

In the six months to the end of June, revenue rose just under 19% to £43m with adjusted pre-tax profits coming in almost 42% higher at £6.5m. Membership numbers climbed almost 20% to 508,000 with the company opening six new sites over H1 and two after the reporting period ended (bringing its total estate to 97 gyms). It now expects to hit the top end of its guidance range for new openings (15-20) over 2017.

Elsewhere, strong cash generation allowed management to reduce the amount of debt by £600,000 to £4.6m. The interim dividend was also raised a healthy 20%, even if the overall yield remains negligible.

Despite all this, I still have concerns over how much investors are expected to pay for Gym’s shares. Before today, the stock was already trading on an expensive forecast price-to-earnings (P/E) ratio of 27. While it’s not surprising that the market liked these figures (Gym’s share price rose 5.5% in early trading), I just don’t see enough upside ahead to warrant this heady valuation. 

With operators competing for the same members in an already saturated market, a lot rests on effective marketing — the costs of which aren’t insignificant. What’s more, memberships are surely among the first things to be sacrificed in the event of an economic downturn — assuming, of course, that people still remember that they have them. With Brexit on the horizon and the stock seemingly stuck in the 175p-210p trading range, I’d be inclined to take any profits sooner rather than later. 

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