Investing in turnaround stocks is popular for a reason — get it right, and you can double or triple your money quite quickly. But it’s a risky habit. Troubled businesses often stay in trouble for longer than anyone expects.
One way to reduce this risk slightly is to limit yourself to the FTSE 350. Businesses at this level should generally have reliable auditors. They should also be able to raise cash by issuing new shares, or borrowing at reasonable rates, when needed.
With these advantages in mind, I decided to take a look at the two biggest fallers in the FTSE 350 over the last 12 months. Is either of these firms worth buying?
A controversial pick?
The last year hasn’t been good for Sports Direct International (LSE: SPD). The firm’s shares have fallen by 55%, and its profits are expected to fall by a similar amount this year.
Mike Ashley, the firm’s colourful founder, has now taken charge, assuming the role of chief executive. But Sports Direct faces headwinds on a number of fronts. The weak pound means that import costs are increasing, as most Asian manufacturers sell in US dollars. Operating costs are also expected to rise by 8%, as a result of the national minimum wage and other changes.
Some of these increases should be offset by rising sales. Sports Direct expects revenue to rise by 9% this year. The firm also has a strong balance sheet, with very little debt.
Sports Direct is continuing to expand its store chain and invest in property. I expect Mr Ashley will manage to pull off some kind of turnaround. What’s less clear is whether the firm’s profit margins will return to historic levels, which were higher than those of most other high street chains.
I don’t see any reason to rush in. I plan to wait until Sports Direct’s half-year figures are published in December, before reviewing the situation again.
More trouble ahead?
Electronics firm Laird (LSE: LRD) has lost 61% of its value over the last 12 months. The vast majority of this was the result of October’s profit warning, when the shares fell by more than 50% in one day.
That’s a very big fall for a single profit warning. The shares now look quite cheap based on the latest broker forecasts, which imply a forecast P/E of 9.6, and a yield of 7%. Is this an opportunity to grab a bargain?
I don’t think so. I believe Laird shares have fallen this far because the market believes the firm is going to have to raise cash from investors. The group’s statement on 19 October made it clear to me that debt is likely to become a big problem. Although net debt should be less than Laird’s banking limit of 3.5 times EBITDA at the end of the year, it’s likely to be close.
Laird’s problems are the result of lower-than-expected production volumes, and price pressure from big customers. It’s not clear to me how the firm will be able to reduce its debt levels.
I’m fairly confident that an equity placing or rights issue will be needed at some point. Until that happens — or the group’s debt falls significantly — I’m going to steer clear.
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Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended Sports Direct International. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.