Are Costain and Craneware falling knives to catch after 30%+ crashes?

Roland Head gives his view on today’s profit warnings from Cranweware plc (LON: CRW) and Costain Group plc (LON: COST).

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Friday morning brought bad news for shareholders of healthcare software specialist Craneware (LSE: CRW) and infrastructure contractor Costain Group (LSE: COST). The both fell by more than 30% in early trading, following serious profit warnings.

Should long-term investors treat this as a buying opportunity, or is more bad news likely? Let’s take a look…

An emergency admission

Four months ago, Craneware — which makes billing software for US hospitals — reported “strong sales activity and opportunities” and “increasing market engagement.” Unfortunately, things seem to have gone downhill since then.

In Friday’s profit warning, the company admitted “the timing and quantity of sales” have been lower than expected during the second half of the year. As a result, sales are only expected to rise by 6% this year, compared to forecasts of 18%.

Profit growth will also be lower. Earnings before interest, tax, depreciation and amortisation (EBITDA) are now expected to rise by 10% for the full year.

What does this mean?

Today’s guidance seems to imply Craneware’s growth has come to a halt during the second half. Reading between the lines, I wonder if the firm’s new Trisus product is taking time to gather momentum.

My sums suggest second half revenue is likely to be about $35m — unchanged from the first half of the year. For a company that’s delivered strong growth every year since 2014, that’s a concern.

Before today’s news, CRW shares were trading on a steep 55 times 2019 forecast earnings. I now estimate this forward multiple at about 32.

Although I admire this firm’s high-profit margins and strong growth record, I think the shares continue to look fully priced. Personally, I’d want to look for an opportunity to buy below 1,800p. I’d await further news before making any trading decisions.

Construction delays

I view infrastructure group Costain as one of the best quality stocks in the construction sector. But today’s news shows the company is still prone to the classic problems for investors in this area — delayed contracts and legacy contract costs.

The firm says projects including the M6 Smart Motorway, Preston distributor road and HS2 Southern Section have been affected by delayed start dates. An upgrade to the M4 motorway at Newport was cancelled by the Welsh government earlier this month.

These setbacks mean underlying operating profit for the year is expected to fall by more than 20%, to between £38m and £42m.

In addition to this, the company will face a one-off £9.8m charge relating to remedial works on a contract that was completed in 2006. The sub-contractor that actually did the work has long since gone bust, leaving Costain carrying the can after all this time.

Profit slump

The latest broker note I’ve seen suggests today’s profit warning is likely to result in Costain’s adjusted earnings per share falling by about 30% in 2019, and by a similar amount in 2020. A matching dividend cut is also expected.

These forecasts price the stock on about eight time earnings, with a dividend yield of 5.7%. Given the uncertain outlook and the risk of a construction downturn, I think the shares look fully priced for now.

For long-term shareholders prepared to ride out the storm, I might hold onto the stock. But otherwise, I’d view this as a sell… until better news emerges.

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 considered so you should consider taking independent financial advice.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Craneware. 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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