Shares that recover from the bargain basement can be some of the stock market’s biggest winners. Today I’m looking at two companies trading on price-to-earnings (P/E) ratios of less than six. Could these stocks deliver outsized returns for investors?
Difficult period
Shares of FTSE SmallCap firm Renold (LSE: RNO) were trading at over 60p little more than a year ago. However, they reached a low of 22p recently after a difficult period for this global manufacturer of industrial chains and torque transmission products.
I believe the issues faced by the business are eminently fixable. Indeed, recovery is already under way, with the shares jumping over 10% on the release of the company’s annual results this morning. At a price of 26.5p, as I’m writing, the market capitalisation is £60m.
Improving outlook
Revenue of £191.6m for the year ended 31 March was 4.5% ahead of the prior year (3.8% ahead at constant exchange rates). Adjusted operating profit of £14.2m was down 2% due to the company being too slow to pass on increased raw materials costs to customers and some factory disruption. However, these issues have been remedied and it’s notable that £8.2m operating profit in the second half of the year was 9% ahead of the same period in the prior year.
Adjusted earnings per share (EPS) for the year came in at 4.5p, giving a P/E of 5.9, and I expect EPS to advance towards 5p this year. Net debt of £24.3m and a net debt/EBITDA ratio of 1:1 are modest and give me no cause for concern. A pension deficit of £97.4m (down from £102m over the course of the year) is substantial but I believe the outlook for such deficits shrinking is improving. While it does represent a risk, the company’s low P/E and prospects of good earnings growth lead me to rate the stock a ‘buy’.
Disaster
Shares of support services and construction firm Interserve (LSE: IRV) have fallen so far that this one-time FTSE 250 company now resides in the FTSE SmallCap index. At a share price of 74p, its market capitalisation is £110m and its P/E is 5.1 based on forecast EPS of 14.5p.
Interserve’s problems have been largely of its own making. A protracted exit from its energy-from-waste business has been particularly disastrous and is also now the subject of an investigation by the Financial Conduct Authority.
Debt millstone
It looked at one stage as if shareholders might be virtually wiped out in a massive debt-for-equity refinancing. However, new management can be credited for pulling off a deal with lenders that is significantly less dilutive than feared. The deal secured borrowing facilities of £834m to 2021, with lenders also able to buy shares at just 10p, giving them ownership of up to 20% of the enlarged equity.
Interserve’s net debt of £503m will rise considerably before any chance of improvement. Due to the size of this millstone, onerous conditions that are attached to the borrowings and the group’s weak underlying performance, I see the risk here as far too high. As such, I rate the stock a ‘sell’.
