Should you pay for quality or hunt for bargains? It’s not always an easy choice.
In this article I’ll look at two industrial stocks that sit on opposite sides in this debate. One is a high performer whose shares have risen by 7% today. The other is raising cash from shareholders to fix its balance sheet, but looks increasingly affordable.
Sales up 4% in tough market
Aerospace and automotive engineering group GKN (LSE: GKN) opened Tuesday’s results with news that its sales rose by 4% to £7,231m last year. The firm’s adjusted pre-tax profit rose by 12% to £678m.
GKN’s adjusted earnings rose by 12% to 31p per share, while the dividend increased by 2% to 8.85p. These figures give the shares a trailing P/E of 11.7 and a yield of 2.4% at 365p.
That seems like a reasonable valuation. But having looked more closely at today’s figures, I’m not sure GKN’s performance and valuation are quite as attractive as they seem.
Too many adjustments?
My main concern is the massive difference between GKN’s adjusted figures and its reported profits. Reported pre-tax profit rose by 19% to £292m in 2016. That’s a healthy increase, but it’s less than half the group’s adjusted pre-tax profit of £678m.
I believe that GKN’s adjustments present a very flattering view of the business. By ignoring the depreciation of certain assets for which the firm paid cash in the past, management can provide a more flattering view of profitability. But as a potential investor, this isn’t what I want.
I would argue that a more realistic view of GKN’s underlying pre-tax profit last year would be about £480m. I estimate that this would translate to adjusted earnings of about 23p per share, which would give GKN a P/E of 15.7.
I should stress that this is only my personal interpretation of GKN’s figures. I still rate this business highly. But for me, the shares aren’t quite cheap enough to buy at the moment.
Will this 50% faller bounce back?
Electronics group Laird (LSE: LRD) has lost half of its market value over the last year. In Tuesday’s 2016 results, chief executive Tony Quinlan said it had been “a disappointing year”. The group announced a statutory loss of £110.8m for 2016 and said it would raise £185m through a rights issue to help reduce debt.
Shareholders will be entitled to buy four new shares at 85p for every five shares they currently own. This gives a theoretical ex-rights price of 135p per share, which is the price at which the stock is expected to trade after the rights issue is completed.
Laird expects to receive £175m after costs. This will be used to repay borrowings, which should reduce the group’s net debt to about £170m. Based on last year’s figures, that will give the group a net debt to EBITDA ratio of about 1.7x. That’s still moderately high, but is comfortably within Laird’s banking limits.
Using consensus forecasts for 2017 and today’s guidance, I estimate that Laird stock will trade on a P/E of about 15 after the rights issue, with a forecast yield of about 2.3%.
I’m still wary about debt, but if trading starts to improve then Laird could become an attractive buy. The shares have gone onto my watch list.
Roland Head has no position in any shares mentioned. The Motley Fool UK owns shares of GKN. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.