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As the Card Factory share price stays cheap, I’d invest £3k

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Risk reward ratio / risk management concept
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The Card Factory (LSE: CARD) share price has been hammered over the past 18 months. Even before the coronavirus pandemic, the business was struggling. Between the beginning of April 2016 and the end of 2019, shares in the company had declined in value by around 56%.

The sell-off accelerated in the first quarter of 2020. During those first three months of the year, the Card Factory share price crumbled around 80% as the pandemic shuttered all of its shops. 

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However, now the UK economy is starting to open up, the outlook for the business is improving. As such, I’d invest a relatively modest sum of £3,000 in the business to profit from the stock’s recovery.

Rocky ride

I’m under no illusion it’ll be plain sailing for this business as we advance. As I noted above, the company was already struggling before the pandemic.

Between 2016 and the group’s 2019 financial year, net profit declined from £66m to £53m. Although sales increased over this period by more than 10%, Card Factory’s profit margin declined as costs and promotions weighed on profitability. 

I think this trend will continue going forward. The UK retail industry is incredibly competitive. That hasn’t changed over the past 12 months. When the company resumes trading from its brick-and-mortar stores over the next few months, it’s going to have to offer customers something to entice them back.

The other challenge the group faces is its debt obligations. Card Factory has had to ask its creditors to waive the covenants governing its debt three times this year. Lenders have obliged up until this point, and the latest waver lasts until the end of April.

Without these waivers, the group may not have survived the crisis. Unfortunately, there’s no guarantee banks will continue to be lenient. 

Card Factory share price outlook

Considering all of the above, I believe Card Factory is an incredibly risky investment. However, I think it also has potential. 

Based on the company’s current market capitalisation of £282m, if it can return to 2019 levels of profitability, the stock could be trading at a ratio of just five times potential earnings. I think that’s far too cheap.

In the past, shares in the business have changed hands for as much as 17 times forward earnings. Of course, there’s no guarantee the retailer will ever return to this level of profitability, or this valuation. 

Put simply, if everything goes right for the company over the next few months and years, I think the Card Factory share price could double or triple from current levels. That’s the best case scenario.

As noted, this is far from guaranteed. That’s why I’d invest in the company today, but limit my stake to just £3k. I think this level of investment would allow me to profit from the group’s recovery without exposing my portfolio to too much risk.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Card Factory. 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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