Stock markets are trading at global highs and many fear share prices may be overvalued, but there are still apparent bargains around. These two UK stocks are trading at around 10 times earnings. They are tempting but also troubled. Should you consider them?
I last looked at outsourcing provider Capita (LSE: CPI) on 21 April, when I posed this question: is it a bargain buy or burnt out case? Its slump followed a year of misery in 2016, when the stock was the worst performer on the FTSE 100, its share price hitting a 10-year low after issuing a profit warning due to one-off costs and client hesitation over spending. It now plies its trade in the FTSE 250.
In April I warned that “turning this crate around will take time” while sharing fund manager Neil Woodford’s belief that Capita does have bounce-back potential. It hasn’t unleashed that potential yet. On 21 April it traded at 567p, today it trades at… 567p! Still, at least management appears to have stopped the rot for now.
Last month’s first-half results were mixed and muddled, with management saying that underlying profits would “rise modestly” in the second half, while reporting that its bid pipeline shrank to £3.1bn from £3.8bn, with contract wins halving to £403m over the period from £879m. That is despite the fact that its winning rate increased from one-in-three to an impressive one-in-two.
Management is working to make Capita a leaner business, but that will take time. City analysts are forecasting a 12% drop in earnings per share (EPS) across 2017, but 4% growth in 2018. Long-sighted investors might see that as a trigger to take a position now, with the stock trading at 9.8 times earnings and yielding 5.7%, nicely covered 1.8 times. You will have to be patient though.
Electricity giant SSE (LSE: SSE) also looks a relative bargain at 11.2 times earnings but again, with a juicy forecast yield of 6.9%. However, share price growth has been non-existent lately, with the stock trading at roughly similar levels to five years ago.
Prime Minister Theresa May’s threat of an energy price freeze has hit the entire sector, with reports yesterday suggesting that energy regulator Ofgem could cap standard variable tariffs to around 18m accounts until 2023. The news had little effect on SSE’s share price, so may have been priced-in.
Hit for six
The big six energy companies now face greater competition from up to 40 smaller suppliers, amid constant comparison site encouragement to get switching. SSE also delivered an underwhelming update last month, warning that adjusted EPS for the full year are likely to be down on last year, with total adjusted operating profit hit by a £150m reduction in adjusted operating profit from its Networks division.
The income should carry on flowing, with management targeting an increase in the full-year dividend of at least RPI inflation, and annual increases thereafter of at least RPI. It is working to keep dividend cover within the expected (thin) range of around 1.2 to 1.4, although at the lower end of that range for the year ahead. SSE is all about the dividend, and that should remain generous. Treat any growth as a bonus.