Thursday was a hugely disappointing day for investors in Interserve (LSE: IRV). The international support services and construction company released a profit warning. This sent its shares as much as 45% lower, with the potential for further falls in the near term.
Clearly, this is an uncertain time for the company and investor sentiment could deteriorate yet further. However, even with added risk, is it worth buying for the long run?
Downbeat trading
The company’s trading update said that trading in the UK in July and August was disappointing. It was particularly bad in the support services division, but was also tough in the construction division. This means that the company now believes that the outturn for the year will be significantly below its previous expectations.
There has been further progress made on contracts within Interserve’s exited Energy from Waste business. However, the planned timing and complexities of completion mean that it is now likely that the final costs will substantially exceed the £160m currently provided. This is expected to have a negative impact on the company’s financial performance in the current year, although it continues to believe that it will be able to operate within its banking covenants for the year ended 31 December 2017.
Risk/reward
Clearly, difficult trading conditions in July and August could continue into September and beyond. In fact, there is scope for a further deterioration in the operating environment, since the outlook for the wider UK economy remains highly uncertain. Brexit has caused the pound to weaken and inflation to spike, while business confidence is at a low ebb. This may lead to less spending and lower economic activity levels, which may create further challenges for Interserve.
That said, the company continues to offer a sound underlying business. And following the share price fall it now appears to have an ultra-low valuation. As such, for less risk-averse investors it could be worth buying for the long run. But its future is likely to be one of high volatility and instability.
Solid growth
A less risky option for the long term is British American Tobacco (LSE: BATS). The company offers a strong defensive growth profile, with demand for its products likely to remain resilient whatever the economic conditions. In fact, the company continues to have strong growth potential within traditional tobacco products, with world population growth and price increases yielding a higher sales figure. And with growth potential within e-cigarettes, the long-term outlook for the business remains bright.
With a forecast growth rate in earnings of 15% in the current year and 10% next year, British American Tobacco has a price-to-earnings growth (PEG) ratio of just 1.6. Given its strong balance sheet, exceptional cash flow and defensive profile, this seems like a low price to pay. As such, it could be worth buying now for the long run.
