Continuing downgrade risks
My concern about RBS was that since the financial crisis, City analysts had been persistently over-optimistic about its recovery, with forecasts for earnings and the timing of dividend resumption proving too rosy again and again.
I found it difficult to see where demand for RBS’s shares might come from. Although they were trading at a 52-week low of around 300p, the consensus earnings forecast was 22.25p, a price-to-earnings (P/E) ratio of 13.5 times, which I thought too high in view of the stubborn trend of earnings downgrades.
An announcement in March that RBS had made a final payment to the Treasury to terminate the so-called Dividend Access Share (one of the precursors for dividends to resume) was a positive, but news has otherwise been disappointing.
The shares are now 26% lower at 222p. But after continuing analyst downgrades, the consensus earnings forecast has fallen 39% to 13.65p, meaning RBS is on an even higher P/E (16.3 times) than in the New Year. I’m looking for a P/E more like 10 or an end to the earnings-downgrade trend, so RBS remains on my ‘avoid’ list.
Centrica’s shares were trading at around 215p when I wrote in January. I thought the valuation — P/E of 12 times and dividend yield of 5.6% — looked attractive, but I had concerns that led me to conclude it was a stock to avoid. These included the low oil price, the new chief executive’s vision for the business, and the early stage of executing that vision.
Today, the shares trade at 208p. The P/E is 13.8 times and the dividend yield 5.8%, reflecting a downgrade to earnings forecasts, but not to dividend expectations. The valuation — particularly the yield — still looks attractive, so have my New Year concerns been alleviated in the intervening period?
The oil-price rally is certainly a positive, although it remains to be seen whether it’s the beginning of a sustained recovery. Results in February were also encouraging, with the company confident its plans and business momentum “will allow us to more than balance cash flows”. Then, out of the blue, came a disconcerting £700m share placing in May. It remains relatively early days for both the oil-price rally and the chief executive, so I’m continuing to avoid Centrica for now.
I’ve been bearish on online household appliances retailer AO World since its stock market flotation at 285p in March 2014. The valuation has always looked too high to me for a low-margin business in an ultra-competitive sector.
When I examined the company in December 2014 at 250p, the EV/EBITDA (enterprise value/earnings before interest, tax, depreciation and amortisation) was an astronomical 66.8 times. It was still an eye-watering 42.9 times at 178p in May 2015 and in January this year it was 42.4 times at 150p.
The shares currently trade at 160p, and using UK EBITDA reported in AO’s annual results this week (excluding lossmaking, early-stage European operations), the EV/EBITDA is 37.7 times. It’s still overvalued in my book — for example, e-tailer Boohoo.com trades at 32 times (on the same trailing 12-month basis), is cash-generative, has better margins and is a generally stronger business in my view. As such, AO World remains another for my ‘avoid’ list.
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G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended Centrica. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.