Why I’m betting on these two 40% fallers for a 2017 recovery

Markets have hit record highs this year, but not all stocks have been lifted by this rising tide. Among the big losers are two stocks I’ve recently added to my own portfolio.

Both stocks have fallen by more than 40% over the last 12 months. But both companies are profitable, cash generative and offer a covered dividend yield of at least 4.5%. I believe these stocks have the potential to deliver decent gains from current levels, hence my recent purchases.

This stock could rise if oil rebounds

Not all companies have benefitted from low fuel prices. Public transport operators such as Stagecoach Group (LSE: SGC) say that lower fuel prices tempt passengers to drive or even fly, rather than take the bus or train.

The group’s shares have fallen by 43% over the last 12 months. This collapse is only partly the result of a 17% drop in earnings forecasts over the same period. Market sentiment has also turned against this sector. Stagecoach shares now trade on a forecast P/E of 8, versus a P/E of 11.3 one year ago.

In my view, this sell-off may have been overdone. The oil market appears to be turning. The weaker pound means that petrol and diesel prices in the UK have already risen significantly. Passenger numbers could soon start to firm up, if the economy remains stable.

Stagecoach also managed to refinance the vast majority of its debt last year, reducing the interest rate on £400m of 10-year bonds from 5.75% to 4%. Although this incurred a £23.3m one-off charge that dented reported profits last year, I calculate that the lower interest rate should save Stagecoach £46.7m over the next 10 years.

This extra cash should help to support the dividend, which at 11.4p per share offers a yield of 5.7%. Earnings per share are expected to be flat or down slightly next year, but I believe the outlook may soon start to improve. I remain a buyer at 200p.

A recovery seems likely to me

Another of this year’s big fallers is Restaurant Group (LSE: RTN), which owns the Frankie & Benny’s chain of eateries, among others. The firm’s shares have fallen by 45% this year, thanks to a series of profit warnings.

However, the group’s problems seem largely to be the result of complacent management, rather than a lack of demand. A recent trading update described mistakes with menu testing, pricing and “poor operational execution.” These all sound like fixable problems to me.

Restaurant Group has responded to its woes by kicking out previous chief executive Danny Breithaupt, a long-standing staffer. He’s been replaced by former Paddy Power boss Andy McCue.

Mr McCue’s success at the bookmaker suggests to me that he’s both energetic and able. I was also pleased to see that he spent £178,500 on Restaurant Group shares within a month of starting work.

Turnaround situations are often made more difficult by financial problems. But Restaurant Group’s finances looks strong to me, with net debt of just £35.6m and free cash flow of £35.8m during the first half of the year. The shares currently trade on a forecast P/E of 12.8, and offer a dividend yield of 4.5%. In my view, this could be a good entry point for medium-term buyers.

Have you looked at this stock?

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Roland Head owns shares of Stagecoach and Restaurant Group. The Motley Fool UK has recommended Stagecoach. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.