Buying shares that have been heavily sold off is a common mistake for beginner investors as shares trading near 52-week lows tends not to pay off. Caught in a downward price spiral, they usually fall further for some time.
Sometimes, though, they bounce back. How do you establish which shares are most likely to recover? Investors should examine the causes of the sell-off, trading outlook and turnaround plans. Let’s do that for three shares trading near their 52-week lows.
Drax Group (LSE: DRX) has been hit hard by the withdrawal of the exemption of biomass electricity generation from the Climate Change Levy. The power generator, which has been switching from burning coal to wood pellets, expects the change to cost it about £60 million annually. This was a complete surprise and undermined the investment case for spending on the conversion of its power plants.
Worse still, wholesale electricity prices have been falling, reducing potential revenues ahead. With profitability squeezed by top-line and bottom-line pressures, Drax’s free cash flow would be much reduced, meaning its dividends are at risk.
Analysts expect underlying EPS to fall by 52% this year, and its dividend to be slashed (again) to 5.6p per share, from 11.9p this year. With earnings momentum clearly trending downwards and dividends shrinking, a recovery just doesn’t seem likely.
Medium term bet
Aberdeen Asset Management‘s (LSE: ADN) shares have fallen less steeply, with a loss of 34% over the past year. Fund outflows this year exceeded 10% of its total assets under management, following the collapse of investor sentiment towards emerging markets in the wake of slowing economic growth and a strengthening US dollar.
But, on the upside, Aberdeen is still hugely profitable and generating substantial free cash flows. Underlying EPS has fallen 5% this year, to 30.6p, but that still leaves the company with a 42.7% operating margin. Core operating cash flow declined by just 2%, to £532 million, allowing the company to raise its dividend by 8.3%, to 19.5p per share. Furthermore, its strategy of diversifying by product and geography should combat fund outflows in the longer term and abate the decline in earnings.
Valuations are cheap too, with a P/E of around 9.8 and a dividend yield of 6.5%. If you’re looking to pick up a quality company on the dip, Aberdeen Asset Management seems to be a great choice. But be warned, with sentiment still negative towards emerging markets, the shares could fall further before making a recovery.
Long road ahead
Lonmin (LSE: LMI) is one of the worst performers this year, with its shares having lost 99% of their value over the past 52 weeks. Platinum prices, at a seven-year low, are largely to blame. But, even before this year’s decline in commodity prices, the platinum miner lagged behind many of its peers, indicating its problems are actually a combination of structural and cyclical factors.
Labour disputes and rising costs have made it difficult for Lonmin to mechanise production, and a significant proportion of its production had been sold below cost price. The miner has a lot further to go in cutting costs, as well as reducing the size of its 36,000-strong workforce. City analysts aren’t optimistic, with forecasts that underlying pre-tax losses will be $46 million in 2016. Unless commodity prices make a spectacular recovery in 2016, Lonmin is unlikely to bounce back soon.
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Jack Tang has no position in any shares mentioned. The Motley Fool UK has recommended Aberdeen Asset Management. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.