1 turnaround stock I’d buy and 1 I’d sell in 2018

Royston Wild looks at two turnaround shares with very different earnings outlooks.

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The uncertain outlook for oil prices in 2018 and beyond means that I am happy to sit on the sidelines rather than invest in London’s quoted crude drillers .

Fossil fuel giant Cairn Energy (LSE: CNE) is one such share I am avoiding today. Rather, I  would consider cashing out of the business today despite a stable operational update released on Tuesday.

Bubbly update

In today’s bright market statement, chief executive Simon Thomson declared today that “over the last 12 months, Cairn has achieved several strategic milestones and is well positioned to deliver on its strategy in 2018.”

For the full year, Cairn said that it expects production to come in at between 17,000 and 20,000 barrels of oil per day, with plateau production from Catcher and Kraken expected at the mid-point of 2017. The FTSE 250 business celebrated pulling maiden oil from these North Sea assets last year.

Looking elsewhere, the third phase of drilling at its JV in Senegal was completed in 2017, and Cairn said that it is now seeking development approval by the close of 2018. First oil from the SNE field is expected between 2021 and 2023, the business said.

And in other news, Thomson said that “we will begin a sustained drilling campaign in the UK and Norway where Cairn has built an extensive portfolio.”

Still too risky

With Catcher and Kraken steadily ramping up production, City brokers expect Cairn to finally flip into the black in 2017. Earnings of 8.7 US cents per share are forecast, and this is expected to improve to 12.2 cents next year.

But I am still not tempted to jump in right now. Instead, with the driller currently changing hands on an elevated forward P/E ratio of 34.4 times, I would consider shifting out before the newsflow worsens.

Crude prices are in danger of reversing again in my opinion, reflecting a hulking supply/demand imbalance that looks set to endure. This situation is casting a shadow on these earnings forecasts, not to mention Cairn’s already-stretched balance sheet (net cash dropped to just $56m as of December from $254m six months earlier).

And of course, the unpredictable nature of fossil fuel exploration and development means that any poor operational updates this year could drive Cairn’s share price sharply lower. There is just too much risk still facing Cairn today, in my opinion.

Defence darling

Those seeking a turnaround titan on safer footing may want to check out Avon Rubber (LSE: AVON) instead.

The business, which builds masks for the military, is expected to see its long record of double-digit earnings growth fall in the year to September 2018 as lumpy contract timings bite — a 16% profits fall is anticipated by City brokers. However, Avon is expected to get firing again with a 4% rise in fiscal 2019.

While the small cap carries a forward P/E ratio of 18.7 times, above the widely-regarded forward P/E ratio of 15 times, this is not a problem for me, despite predictions of a hefty near-term profits fall.

News of booming orders has sent the defence giant’s share price spiralling higher in recent months, and with defence budgets on the mend and conditions in the dairy market also getting better (Avon also makes hardware for milk extraction), the Melksham firm’s earnings outlook is likely to keep on improving.

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.

Royston Wild 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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