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3 Turnaround Plays: BAE Systems plc, Pearson plc And Kingfisher plc

Choosing companies with turnaround potential can be one of the most profitable methods of selecting shares. Turnaround shares are companies that have performed badly in recent years, but are also set to see their earnings recover, after a prolonged period of operational headwinds. The forward-looking valuations of these shares tend to be more attractive, as these companies have fallen out of favour with investors.

Here are three shares that should show a recovery in earnings in the near term:

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BAE Systems

BAE Systems (LSE: BA), which has been suffering from government cuts to defence spending, is seeing a pick-up in new equipment and servicing contracts. Although the trading environment of the defence sector is still challenging, the market seems to be stabilising, as economic conditions improve and tensions in Eastern Europe and the Middle East increase.

Underlying EPS fell 10% to 38.3 pence in 2014; but there were signs that a recovery is in sight. BAE secured $4.3 billion worth of new orders from outside its core UK and US market, and its cyber-security business saw its order backlog grow 37% in the year. Overall, its order backlog totals 40.5 billion, which is worth 2.5 times its 2014 revenues.

Analysts expect underlying EPS will rise 1% to 38.3 pence this year, with growth accelerating to 6% in 2016. Although, there is no guarantee that BAE can return to its past growth trajectory, its long term servicing contracts and strong order book should mean that earnings would bottom out soon. Its valuation is also reasonable, with a forward P/E of 12.2 and a prospective dividend yield of 4.4%.

Pearson

Pearson’s (LSE: PSON) earnings has been steadily declining over the past three years, as its US education businesses struggled with lower spending budgets and changes to the curriculum.

Its transition from print to digital products, as part of its major restructuring programme, is finally showing signs of success. Online services for undergraduate and graduate learning programmes saw course enrolments rise 22% in 2014, with potential for further growth as more higher education institutions sign up to its services. Pearson’s innovative step towards digital products has so far not led to margins improvement, but this should soon change as it signs up more new customers, and because much of the costs are fixed.

Analysts expect underlying EPS will rise 16% to 77.1 pence this year, which gives its shares a forward P/E of 15.9. Its dividend should increase by around 7% to 54.8 pence, giving Pearson a prospective yield of 4.4%.

Kingfisher

Kingfisher (LSE: KGF), the owner of B&Q, Screwfix and other home improvement stores, is struggling with the weak trend in DIY spending and the rise of specialist format rivals, such as Toolstation, Wallpapermarket and Victoria Plumb. But, Kingfisher is fighting back with the expansion of its own specialist omni-channel format, Screwfix, across the UK and Germany. Sales for Screwfix grew 26.8% in its first quarter, outpacing overall growth of just 2.7%.

Many of its store layouts seem outdated, and the lack of synergies across its businesses is keeping its operating costs high. But this is something management is attempting to sort out, following the findings of its strategic review, by sharing infrastructure across its European businesses and standardising its processes.

With a strengthening UK and European economy, there is substantial potential for growth in the home improvements market. Analysts expect underlying EPS will rise 5% to 21.9 pence this year, which gives its shares a forward P/E of 16.0. Kingfisher also has a prospective dividend of 2.9%. 

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

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