Why Shares In Latchways plc Are Slumping Today

housebuildingProtective equipment producer Latchways  (LSE: LTC) has slumped over 25% in early trade this morning following a profit warning. 

The company has fallen victim to challenging European economic conditions, as customers have delayed capital projects in the light of the poor outlook. What’s more, Latchways has suffered from delays in the European offshore wind energy business and a de-stocking by one of the company’s largest North American customers.

Still, on a positive note, Latchways has been able to ride the construction sector recovery closer to home, and the company’s UK divisional performance is strong. 

Nevertheless, strength within the UK market has not been enough to offset weakness elsewhere. As a result, management now expects pre-tax profit for 2014 to be materially below last year’s level of £6.8m. The company is currently forecasting a full-year pre-tax profit of £4.5m to £5.5m, down nearly a third on last year. This will be the second year that Latchways has reported a decline in pre-tax profit. 

Room for growth 

Despite today’s profit warning, Latchways’ management remains confident that the company will resume profitable revenue growth next year. And it’s easy to agree with this view. Indeed, as a leading designer and manufacturer of fall protection systems for working at height, the company’s products and services will always be in demand. 

Further, with over 30 years of history behind it, Latchways knows how to handle short-term market weakness — the company’s not going to disappear overnight. 

What’s more, Latchways has a strong cash balance of £10m and continues to generate cash. So, the company is not in any real financial trouble. While trading is slower than expected, cash is still flowing into the company’s coffers and funding the dividend payout. The company’s shares currently support a dividend yield of around 4%, an attractive yield in the low interest rate environment.

Unfortunately, on a valuation basis Latchways looks to be extremely expensive. Yesterday, before today’s news broke, Latchways was trading at a forward P/E of 16.1. This high valuation was justified as City analysts were expecting the company to report earnings growth of 22% this year. 

However, now Latchways expects earnings to fall by a third this year, the company does not deserve a lofty valuation in the high-teens. By my calculations, even after today’s declines, adjusting for a lower pre-tax profit, Latchways is still trading at a mid-teens P/E ratio. 

Overall, today’s trading update from Latchways is disappointing and the company now looks expensive at current levels but as usual, it remains your decision whether you buy, sell or hold Latchways’ shares.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK owns shares of Latchways. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.