Shares of industrial services firm Cape (LSE: CIU) fell by more than 15% this morning, after the firm warned that it may be forced to scrap the dividend if it loses a new legal case.
In this article, I’ll ask whether the potential rewards of Cape’s high yield outweigh the risk of an investment. I’ll also ask whether it’s time to buy technology firm Oxford Instruments (LSE: OXIG), following the group’s latest disposal.
Asbestos claims could sink dividend
Cape’s latest trading update had two parts. The first section indicated that recent trading has been in line with expectations. Full-year profits are expected to be slightly better than expected, thanks to recent exchange rate movements.
The latest consensus forecasts show that Cape is expected to report full-year adjusted earnings of 24.4p per share. This puts the stock on a forecast P/E of just 6.6, with a forecast dividend yield of 8.7%.
Extremely high yields and low valuations are usually a warning that the market expects problems. Cape is no exception. The group said this morning that it has increased the provision made against industrial disease claims by £9.6m. That’s not great news, but it isn’t the reason for today’s dramatic slump.
The final part of today’s update warned shareholders that new product liability litigation relating to Cape’s historic use of asbestos could lead to “an extended period of uncertainty.” Management warned that if the case goes against Cape, the dividend could be suspended.
This case was previously reported in last year’s results, but the tone of today’s statement is more negative than previously. Although Cape believes “the merits of our defence are persuasive,” the group admits that there’s no certainty about the outcome.
Markets hate uncertainty, and this is why Cape shares are so cheap, despite the group’s solid trading. In my view, the stock is too speculative to buy at the moment.
Oxford could be a better choice
Shares of Oxford Instruments are worth 20% less than they were at the start of the year, but I believe the outlook is improving for this maker of hi-tech industrial tools.
The company said today that it had sold its superconducting wire business (OST) for $17.5m. Trading had been difficult for some time, and while OST is profitable, Oxford’s figures show that OST’s operating profit fell by 33% during the first half, to just £1.1m.
Cash from this sale will be used to reduce Oxford Instrument’s net debt, which was £141.1m at the end of September. This represents a level of 2.6 times earnings before interest, tax, depreciation and amortisation (EBITDA). Net debt of more than two times EBITDA is generally considered high, so I’m pleased that the group is focusing on debt reduction.
November’s interim results suggest Oxford Instruments’ trading has stabilised. Adjusted earnings from continuing operations were just 1.4% lower, at 21.4p per share. The interim dividend was left unchanged at 3.7p.
This year’s results are expected to be broadly unchanged from last year, but consensus forecasts suggest earnings could rise by about 10% in 2017/18.
The shares currently trade on a 2016/17 forecast P/E of 12, and offer a 2.1% yield. I believe this could be a good time for turnaround investors to start buying.
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Roland Head 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.