The Motley Fool

Why I’m not piling into this FTSE 100 turnaround stock just yet

When I last wrote about medical products firm ConvaTec Group (LSE: CTEC) in June, I warned that shareholders faced risks from high debt levels and slowing growth.

The stock looked expensive to me back then — but I wasn’t expecting Monday’s sales warning, which wiped around 25% off the group’s share price. A mix of supply issues and lower order levels than expected mean that revenue will rise by just 1%-2% this year, against previous guidance of 4%.

Claim your FREE copy of The Motley Fool’s Bear Market Survival Guide.

Global stock markets may be reeling from the coronavirus, but you don’t have to face this down market alone. Help yourself to a FREE copy of The Motley Fool’s Bear Market Survival Guide and discover the five steps you can take right now to try and bolster your portfolio… including how you can aim to turn today’s market uncertainty to your advantage. Click here to claim your FREE copy now!

As the dust starts to settle, the shares have steadied at about 212p. But despite this modest rebound, ConvaTec stock is now cheaper than at any time since its flotation in late 2016. The shares now trade on a 2017 forecast P/E of about 15, falling to a P/E of 13 for 2018.

A buying opportunity?

I believe it’s probably too soon to buy.

Management is still “reviewing the financial implications for growth and margins” in 2018. Chief executive Paul Moraviec has promised “further guidance” early next year, but the phrasing of his comments suggests to me that bad news is likely.

It’s also worth noting that ConvaTec is yet another example of an IPO that’s disappointed the market during its first year of public trading. In my view, it pays to be suspicious about recent flotations at the moment. Are the outgoing owners simply looking to cash in ahead of tougher times?

In ConvaTec’s case, I’ll be looking for clear evidence of stable profits and further debt reduction before considering an investment. For now, I’m going to stay away.

A smoother ride?

Troubled modelling and collectibles group Hornby (LSE: HRN) issued another profit warning this morning. The news follows the appointment of new chief executive Lyndon Davies. Mr Davies is the chairman and controlling shareholder of the Oxford Diecast model and collectible business.

Following his initial review of the business, Mr Davies has decided that to protect the value of the group’s brands, it will no longer offer discounted stock to volume buyers. Although the company had already warned shareholders that full-year results were likely to be below expectations, today’s statement confirms that there will be “a material impact on profitability” this year as a result of lower sales.

Time to buy?

At 32p, Hornby’s shares currently trade nearly 10% below their book value of 35p per share. I admit that the long heritage of brands such as Hornby, Airfix and Scalextric is a potential attraction. But I think investors need to ask if the stock is really cheap enough to be a compelling buy.

The last time this group reported a profit was in 2012, when it generated an operating margin of 7.4%. If this had been applied to last year’s sales of £47m, I estimate that the company might have reported earnings of about 3p per share, assuming a 25% tax rate.

That would give a P/E of 10.6 at the current share price of 32p, which seems fair. My concern is that Hornby is only expected to report earnings of 1.3p per share in 2018/19, giving a forecast P/E of 26.

In my view, a reasonable recovery is already priced into the stock. I’m not sure the shares are cheap enough to be a great turnaround buy.

5G is here – and shares of this ‘sleeping giant’ could be a great way for you to potentially profit!

According to one leading industry firm, the 5G boom could create a global industry worth US $12.3 TRILLION out of thin air…

And if you click here, we’ll show you something that could be key to unlocking 5G’s full potential...

It’s just ONE innovation from a little-known US company that has quietly spent years preparing for this exact moment…

But you need to get in before the crowd catches onto this ‘sleeping giant’.

Click here to learn more.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.