The Interserve (LSE: IRV) share price has collapsed to a level not seen since the 1990s. A recent mini recovery from 55p to 85p might suggest the tide has finally turned for this support services and construction company, but there’s one overriding factor that leads me to rate the stock a ‘sell’.
Finsbury Food (LSE: FIF), which released its latest half-year results today, is another stock I have tagged as a ‘sell’. This speciality baker has been a considerably more solid performer than Interserve and there’s a different reason for my negative view on its buoyant shares.
One big problem
After a string of operational problems, poor trading and boardroom changes during 2017, Interserve issued better news in January. It said it expected operating profit in 2018 to be “ahead of current market expectations,” with new management confident it has identified initiatives that will “contribute at least £40m-£50m to group operating profit by 2020.”
For 2018, City analysts are forecasting a bottom-line profit of £48m, so with a market cap of £124m at the current share price, Interserve’s forward price-to-earnings (P/E) ratio is an incredibly low 2.6. However, I don’t believe this is the bargain it appears, due to the company’s massive net debt of over £500m.
I’m not quite as pessimistic as my Foolish friend Alan Oscroft, who has argued Interserve could go the way of Carillion, leaving shareholders with nothing, but I do think the shares could fall considerably lower than their current level. The Telegraph reported earlier this month that since the start of the year, private equity outfit Emerald Investment Partners has been quietly buying up Interserve’s debt from the likes of Lloyds and Barclays “for as little as 50p in the pound” and “may now own as much as a third of [the] loans.”
When debt is changing hands at such a discount, it’s generally bad news for existing equity. Emerald clearly sees a viable business but I believe a refinancing of Interserve, including a debt-for-equity swap, would likely come at a heavy cost to current shareholders.
Multiple headwinds
Finsbury Food has no such problems with debt. At a share price of 116p (unchanged on the day), its market cap is £151m, while net debt stands at just £16.6m. In addition to its strong balance sheet, the company is trading pretty well, with today’s results showing low single-digit top-line growth and mid single-digit bottom-line growth.
For Finsbury’s full financial year to 30 June, City analysts are forecasting a net profit in the £30m region, giving a P/E of 11.6. And there’s a dividend yield of 2.8% on a forecast payout of £4.3m.
The company acknowledges it faces Brexit uncertainties and a number of continuing challenges, including increased commodity prices and the annual above-inflation increase in the National Living wage. While management is working hard to “mitigate” the headwinds and believes it has a “resilient” business, I don’t see a P/E of 11.6 and dividend yield of 2.8% as sufficient reward for mitigation and resilience.
Finsbury is a decent, well-managed company but one which will have to run just to stand still in the prevailing challenging environment. In these circumstances, I believe the risk of earnings downgrades is significantly higher than the potential for upgrades and I see more appealing investment propositions elsewhere in the market.
