This FTSE 250 stock crashed 30% in December. Why I’d buy it for 2021

Near-term uncertainties have hit this FTSE 250 stock, but it’s undervalued and can bounce back in 2021, argues G A Chester.

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The share price of FTSE 250 stock Avon Rubber (LSE: AVON) hit a new all-time high on 1 December. However, the market reacted badly to annual results the following day and an unscheduled trading update on 17 December. As a result, the share price is now some 30% below its level at the start of the month.

I think the market’s overreacted and presented me with an opportunity to buy discount shares in a great business. Here’s why I believe Avon can bounce back in 2021. And why the current valuation doesn’t reflect its medium-to-long-term growth prospects.

Flying FTSE 250 stock

2020 has been a transformational year for Avon. It sold its agricultural technology business for £180m, and is now focused solely on defence. Here it’s “a world leader in respiratory and ballistic protection, delivering life-critical solutions for militaries and first responders.”

The company expanded its product portfolio in body armour and helmets with two acquisitions during the year. It paid £96m for 3M’s ballistic protection business and £100m for helmets specialist Team Wendy.

The market applauded the strategic developments, as well as a strong organic operating performance. When the FTSE 250 stock made a new all-time high of 4,625p on 1 December, shareholders had enjoyed an uplift of 121% since the start of the year.

Turn in sentiment

The next day, Avon released its results for its financial year ended 30 September. Despite the unprecedented challenges of Covid-19, it had seen “only minor disruption.” And the results were “strong” and “ahead of expectations.” Furthermore, the business was positioned to “deliver further growth in 2021 and beyond.”

Yet, before the middle of the month, the shares were trading at 3,765p, In other words, this FTSE 250 stock had lost around 20% of its value from its pre-results high. I put this down to some serious profit-taking after the year’s strong performance.

Due to the discount and Avon’s growth prospects, I made it my pick in our Motley Fool ‘Top British shares for 2021’ feature published on 14 December. Three days later, the company issued an unscheduled trading update.

Uncertainties

Avon announced a problem in testing initial production samples of body armour plates for two contracts. It said it’s“confident” of resolving the issue, but expects a delay to first deliveries. In addition, a competitor has protested against the award of a sole-source contract to Avon for a next-generation ballistic helmet.

These near-term uncertainties are unwelcome. However, I expect clarity to improve in the coming year, and the market to refocus on Avon’s compelling medium-to-long-term growth prospects.

Still a top FTSE 250 stock

City analysts have revised their financial forecasts since the 17 December update. At a share price of 3,250p, Avon’s trading at 33 times forecast earnings for its financial year ending 30 September 2021. And the multiple falls to 25 for fiscal 2022 on forecasts of 32% earnings growth. The 2021-22 price-to-earnings growth (PEG) ratio of 0.8 is on the good-value side of the PEG fair-value marker of 1.

Despite the near-term uncertainties, I continue to see Avon as a top FTSE 250 stock. It not only has prospects of strong organic growth, but also a balance sheet capable of supporting further earnings-enhancing acquisitions. As such, I’d be happy to buy it for 2021 and the long term.

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.

G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended Avon Rubber. 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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