Why I’d ditch this triple-bagging growth stock today

Roland Head takes a closer look at two stocks with rising profits from the natural resources sector.

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Today’s third-quarter update from engineer Weir Group (LSE: WEIR) kicks off with news of a 21% increase in orders, compared to the same period last year.

The firm’s all-important Oil & Gas division has seen a 59% rise, while the Minerals division, which serves mining customers, saw orders increase by 12%. So why did Weir fall by around 6% when the market opened?

Unfortunately, today’s update also included a profit warning. Operating profit is now expected to be “slightly lower than previously indicated” this year. According to management, this is because of project timing in the Minerals division, along with investment in future growth and plant reconfiguration.

Should investors be worried?

Digging into the detail in today’s statement, it seems that despite impressive order growth during the third quarter, Weir’s overall order book may have shrunk slightly during this period.

The group’s book-to-bill ratio — which compares new orders with billed-for completed work — fell from 1.06 at the end of June to 0.95 at the end of September. A number below 1 indicates new orders aren’t sufficient to replace completed work.

I see this as a short-term issue that’s unlikely to persist. The company’s main markets — oil and mining — are enjoying periods of recovery and growth. Looking ahead over the next few years, I’d expect Weir to do the same.

After today’s fall, the stock trades on a forecast P/E of around 22, with a prospective yield of 2.2%. In my view, this is probably about right. I’d continue to hold, but I don’t see the shares as a compelling buy.

How safe is this triple-bagger?

Shares of copper miner KAZ Minerals (LSE: KAZ) have risen by 186% over the last year. That’s pretty close to a triple-bagger.

However, this spectacular recovery is also a reminder of the biggest risk facing KAZ Minerals’ shareholders — debt. At the end of 2016, the group had net debt of $2.7bn and full-year earnings before interest, tax, depreciation and amortisation (EBITDA) of just $492m.

This gave the stock a net debt-to-EBITDA ratio of 5.4, more than double the widely-used limit of 2.5 that most investors find comfortable. The outlook was decidedly risky.

Fortunately, things have improved since then. The price of copper has risen by about 40% over the last year. Alongside this, KAZ has ramped up its own output, increasing its guidance for full-year copper production from 225,000-260,000 tonnes at the start of the year to 250,000-270,000 tonnes at the end of September.

Selling into a rising market has helped to boost the group’s earnings. During the first half of this year, EBITDA rose to $505m. This six-month figure is roughly equal to EBITDA for the whole of last year.

As a result, the group’s net debt had fallen to $2.2m by the end of September, a reduction of more than $400m in nine months.

I still wouldn’t buy

Although KAZ trades on a 2017 forecast P/E of 11, the group pays no dividend and appears to have cut capital expenditure to a minimum in order to fund interest payments and debt reduction. This situation may be hard to sustain without sacrificing future production growth.

I think the risk of disappointment is growing. I’d take profits on KAZ.

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 positions in any of the shares mentioned. The Motley Fool UK has recommended Weir. 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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