The Burford Capital share price isn’t the only Neil Woodford disaster stock I’m avoiding

It may be showing signs of recovery but Paul Summers thinks this battered small-cap, like shares in Burford Capital Ltd (LON:BUR), should be left alone for now.

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Neil Woodford can’t catch a break. His latest nightmare comes in the form of litigation finance specialist Burford Capital (LON: BUR) — a former hot stock that more than ten-bagged in value between 2015 and 2018 and was a significant holding in his now-gated Equity Income fund.

If you haven’t done so already, I urge you to read my Foolish colleague Rupert Hargreaves’s summary of the company’s current situation after coming under scrutiny from US investigative research firm Muddy Waters.  

Unfortunately, Burford’s decision to issue a statement designed to counter the latter’s claims that its investment returns were misleading has backfired. The share price declined 54% yesterday as investors fled for the exits and traders joined Muddy in betting against the company.

But Burford isn’t the only Woodford holding that’s been a target for short-sellers. Another has been breakdown recovery provider and insurer AA (LSE: AA) — currently the joint second ‘most hated’ share on the London Stock Exchange.

Road to recovery

Releasing a pre-close trading update to the market this morning, AA predicted that earnings over the six-month period to the end of July will beahead of last year”, although FY2020 performance will still be weighted to the second half.

Positively, the company stated that its paid personal membership base was stabilising (falling roughly 0.5% compared to the 1.1% over the same period in 2018) and that it would start growing again in the next financial year. Elsewhere, AA’s Insurance arm was performing as predicted with its motor and home books growing by 10% and 1.3% respectively.

Looking ahead, the small-cap said that it’s on track to deliver full-year earnings growth in line with what the market is expecting and “strong” free cash flow of around £80m. 

Having declined over 80% in value over the last three years, AA’s shares can be picked up today for just 5 times forecast earnings. That might appear screamingly cheap in light of today’s numbers and recent developments (including a deal with Admiral to offer breakdown services to its customers), but I’m still wary.

Regardless of its ability to throw off cash, few would deny that the company’s net debt (£2.7bn at the end of the last financial year) is still nothing short of terrifying for a company only valued at £300m. Moreover, I’d want proof that recent, substantial investment is paying off and membership numbers are actually growing, especially as the competitive breakdown industry could become even more so in the event of an economic downturn as more of us hunt for bargain cover.

AA may be spluttering back to life but it remains firmly in my ‘avoid’ pile until there’s clear evidence of it moving into a higher gear. 

Too risky

Returning to Burford, it seems likely that the share will remain under pressure until the company has a) taken formal action against Muddy Waters, b) management has taken advantage of the share price collapse to top up their holdings, or c) both. The fact that the shares aren’t bouncing as one might reasonably expect following a huge fall and investors’ collective love for a bargain is an ominous sign.

Taking a contrarian stance when presented with all the facts is one thing, but I think there’s simply too much uncertainty at the current time for Burford to be considered anything more than a punt. And that’s not the Foolish way.

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.

Paul Summers 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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