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Is this battered stock a buy after 62.5% dividend cut?

A dividend cut is usually a sign of a business that’s in trouble. But sometimes it’s a preventative measure, taken to avoid future problems.

Today I’m looking at two companies where shareholders have had to accept big pay cuts. In both cases I think the decision to cut reflects well on management. Both companies have lagged the market over the last year, but now seem poised to deliver rising profits.

Is now the time for contrarian investors to start buying?

Ignore this one-off cost

Novae Group (LSE: NVA) is a specialist insurer that trades in a variety of sectors. One part of Novae’s operations deals with providing reinsurance for UK motor insurance firms.

Novae’s share price fell sharply last week after the firm admitted that the Ogden rate cut might result in a dividend cut.

The full scale of the damage became clear when Novae published its 2016 results today. Pre-tax profit fell from £59.1m pre-Ogden to £23.7m, while the group’s return on equity fell from 15.5% to 6.6%.

The final dividend was cut by 62.5% from 20p to just 7.5p, giving a total of 15p per share for the full year.

Novae shares fell sharply when markets opened, but have bounced back rapidly. I think I know why. Without the Ogden hit, the firm’s 2016 results would have been quite good. Gross written premiums rose from £787m to £901m. Pre-tax profit would have risen from £52.4m to £59.1m.

The latest broker forecasts suggest that Novae’s earnings will rise to 62.5p per share in 2017. That gives a forecast P/E ratio of 9.9 at the current price. Although it’s not yet clear how much of a dividend the group will pay in 2017, I’d expect a yield of at least 3%. Now could be a good time to take a closer look.

This ambitious move could pay off

When Majestic Wine (LSE: WINE) splashed out £70m to acquire Naked Wines in 2015, there was a sting in the tail for shareholders. The dividend was suspended to help pay for the deal. In fairness, this was a better option than overloading the balance sheet with debt. But progress so far has been mixed.

Although sales at the enlarged Majestic group have risen from £284m in 2014/15 to an expected level of £450.6m this year, profits have fallen sharply over the same period. Analysts expect Majestic to report a net profit of £9.4m for the year ending 28 March, down from £13.5m in 2015.

The problem is that Naked Wines isn’t yet reliably profitable and the group has had to cut prices in its core UK retail business, in order to match supermarket competition.

The good news is that Majestic does seem to be making progress. Like-for-like sales in the Majestic retail business rose by 7.5% over Christmas. The group’s total sales rose by 12.4% over the 10-week Christmas trading period. This is important, because about 30% of Majestic’s annual sales are generated during the festive season.

Net debt remains low at £25m and the dividend has now been reinstated. Analysts put the stock on a P/E of 27 for 2016/17, falling to a P/E of 19.2 for 2017/18. I’d hold at these levels ahead of June’s final results, but bold buyers may want to add more.

Can you beat this growth opportunity?

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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.