I bought this income stock at £1.84. So why am I not buying it at £1.57?

Stephen Wright’s concerned that rising debt suddenly makes Forterra shares risky, despite the stock looking stable from a passive income perspective.

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I’ve thought for some time that Forterra’s (LSE:FORT) a stock that could be a valuable source of income. But the last few weeks have been troubling for the brick manufacturer’s shareholders.

A disappointing set of results has caused the share price to fall by 10% over the last month. I was happy buying the stock at £1.84 – suddenly the shares are at £1.57 and I’m not so sure.

What’s happened?

It’s no secret that housebuilding activity’s been dampened over the last year by high interest rates. And Forterra’s results reflect this, with revenues down 24% and earnings per share down 57%. 

As a Forterra shareholder, I don’t have much of a problem with this. The business operates in a cyclical industry and there isn’t much that management can do about this. 

The downturn in the construction industry’s been having an effect on the company’s balance sheet though. The company’s net debt’s gone from £6m to £93m over the last 12 months. 

I think this is why the company’s lost around £38m in market-cap over the last month. It’s a big increase and it has me concerned.

Debt issues

Three things are bothering me about Forterra’s debt. One is the amount – £93m’s a lot for a company generating £44.1m in EBITDA – and it will have to be paid back sooner or later. 

Another is the fact the company’s felt the need to relax its debt covenants. To give itself some headroom, Forterra’s asked to change the required debt limit from three times EBITDA to four. 

Possibly the biggest issue I have though, is that the stock’s still paying a dividend. With debt rising, I’d much rather management cut the dividend entirely and restored strength in its balance sheet.

I’d rather Forterra prioritised getting in position for when housebuilding activity starts to pick up. But the company seems to be focused on paying a dividend, which is why I’ve stopped buying.

Should I sell?

As I see it, the underlying business has changed from where it was a year ago in ways that go beyond the usual cyclical ups and downs. With that in mind, should I consider selling my stake in Forterra?

I’m not ruling out selling, but I still like the long-term outlook for the company. The shortage of houses – and the bricks needed to build them – is the reason I was first attracted to the stock. And that’s still the case.

As a result, I still think Forterra shares can be a good source of income for an investor over the long term. But I see the short-term commitment to the dividend as a drag on the long-term returns.

With where the stock is at the moment, I’m not inclined to either buy it or sell it. But that could change in the future, depending on where the share price goes from here.

Hold

For me, the situation with Forterra shares is simple. I’ll consider selling them if the price goes up a lot and I’d be willing to buy more if the next move is significantly down.

Right now though, my estimation of the intrinsic value of the business is lower than it was. So while I was willing to buy the stock at £1.84 a month ago, I’m not so keen today at £1.54.

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.

Stephen Wright has positions in Forterra Plc. 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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