Should we now pile into IDOX plc after crashing 25% today?

Roland Head explains what’s gone wrong at IDOX plc (LON:IDOX) and gives his verdict on the stock.

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Shares of public sector software specialist IDOX (LSE: IDOX) fell by 25% this morning, after the firm issued its second profit warning in just two months.

Investor confidence in the stock won’t be helped by news that today’s warning appears to be the result of accounting errors. These have now been reported to the group’s auditors and will delay the publication of full-year results — due in December — until February.

What’s gone wrong?

The firm says that staff have identified some revenue items “that it does not consider should be recognised in the FY2017 results”. Removing these items from the 2016/17 accounts is expected to reduce earnings before interest, tax, depreciation and amortisation (EBITDA) from £23m to £20m.

The company says that sorting out these issues has been “complicated” by the “sudden absence” due to illness of the group’s chief executive Andrew Riley.

No information has been provided about the nature of the accounting problems, but one possibility is that revenue from multi-year contracts has been recognised too early. This is an area that’s caused problems for other service companies in recent years.

Buy, sell or hold?

Today’s news is a reminder of the old stock market adage that profit warnings usually come in threes. We’ve now had two warnings from the firm, leaving a number of questions unanswered.

Using the information in today’s statement, I estimate that full-year adjusted earnings could be around 3.1p per share. That would put the stock on a forecast P/E of 13, at current levels.

In my view this is still too expensive. I plan to review this stock again when management provides a full set of accounts and updated guidance for 2018/19. In the meantime, I’d rate it as a sell.

A value trap?

Earlier this year, I was bullish about African miner Petra Diamonds (LSE: PDL). But the firm’s situation has worsened considerably since then. I now believe this stock is in danger of becoming a value trap.

Petra Diamonds has been spending heavily on expanding its Cullinan and Finsch mines. This work is now largely complete and both mines are ramping up production. The problem is that spending on Cullinan has left the company with raised debt levels, just as its operations are being disrupted elsewhere.

Double whammy

In South Africa, Petra has experienced disruption from strike action at a number of its mines. Meanwhile sales of diamonds from Tanzania have been disrupted by a government crackdown on exports. This has affected several London-listed miners.

As a result, the group reported net debt of $613.8m at the end of September. That’s nearly four times last year’s adjusted EBITDA of $157.2m and has left the group at risk of breaching some of its banking covenants.

Brighter outlook for 2018?

Problems in Tanzania are receding and performance is expected to improve in 2017/18. Debt levels may fall without the firm needing fresh funding.

But Petra has already warned that industrial unrest and “the uncertain outlook” for its Williamson mine in Tanzania could hit performance over the coming year.

The stock currently trades on a 2017/18 forecast P/E of 7.7. In my view this modest valuation is high enough, given the financial risks facing shareholders. If Petra’s debt problems persist and cash runs short, these shares could have further to fall.

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 position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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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