If I see a FTSE 100 stock that has lost almost half its value in a month, there’s usually a big story involved. Yet for an investor, it’s important to look beyond the media noise and determine whether the impact will be material. If it’s only a short-term problem, could it represent a smart buying opportunity? Let’s find out!
The sharp fall
I’m talking about the 24% drop in 3i Group (LSE:III). It’s a private equity investment business, meaning it buys and sells stocks that aren’t listed on the stock exchange. This can offer lucrative returns (the stock is up almost 200% in the past five years) but also carries a level of risk.
It’s this risk that has been on people’s minds following the Q3 trading update earlier this month. In it, the language used was very cautious, saying that market conditions for deal-making remain “challenging”, particularly given macroeconomic and geopolitical uncertainty. This isn’t great, both for finding new opportunities to invest and for selling any holdings for a profit.
This was evident with its largest holding, Action. Like-for-like sales growth at Action has reportedly weakened, especially in France, raising concerns that 3i’s earlier growth projections may be too optimistic. If it continues to underperform, it could really drag on 3i overall, given that it represents 71% of its portfolio. This is the largest concern going forward for many investors.
Why I’m not worried
3i has built its reputation on making a small number of concentrated bets on businesses. For example, when it first took a stake in Action in 2011, it had 250 stores across three countries. It now has over 3,000 stores in 15 countries. So the investment managers clearly have a good track record of allocating capital.
Right now, this concentration risk is spooking some investors. It might be that 3i is looking to sell some of its holdings. I don’t see this as a bad thing, as it provides cash to then put to work elsewhere.
Let’s also remember that the latest update showed £1.64bn in liquidity, including cash and undrawn credit. Net debt is also low. So, despite concerns about the overall valuation, I have no concern that it will seriously impact the overall business’s financials.
Finally, let’s look at the long-term view. Private equity markets have periods of weakness just like the stock market. It’s normal. So the sell-off seems to be more around rising caution rather than a fundamental collapse.
Even though I think it would be wise for 3i to reduce its exposure to Action as putting all its eggs in one basket remains a risk, I think the fall is overdone. On that basis, it’s a stock that I’m seriously thinking about adding to my portfolio in the coming weeks.
