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Why I’d avoid Carillion plc and buy this growth stock instead

Once touted as one of the market’s top dividend stocks, shares in Carilion (LSE: CLLN) have slumped 82% this year following a string of profit warnings. 

And now, questions are starting to arise about the company’s future. The firm’s deepening problems show no sign of abating, and lenders are losing patience. 

With this being the case, I think it’s time to dump this struggling fallen angel and reinvest funds into one of London’s most promising growth stocks. 

Trouble brewing 

I believe that the chances of Carillion ever returning to its former glory are slim, as to rebuild its balance sheet, the group will need to shrink drastically. 

In 2014, peer Balfour Beatty made an offer to buy Carillion in a £3bn merger. Today, the company’s market value has fallen to just £185m, and net debt is three times greater. Indeed, according to analysts, net debt will average £850m this year, so management’s immediate priority is to reduce debt to about 1.5 times earnings before interest, tax, depreciation and amortisation — around £350m. 

To hit this target, the group is projecting £300m of proceeds from asset sales, cost savings, and there’s talk of a £200m rights issue as a final stopgap. There’s also a £650m pensions hole to fill.

Cash flow problems 

The scale of this challenge should not be underestimated. Carillion remains on track to report pre-tax profits of over £100m this year, but I believe what the firm really needs is cash. 

According to my calculations, even though the company has generated £771m in pre-tax profit during the past five years, free cash flow over the same period (cash from operations minus capital spending) was only £28m. Between 2012 and 2016 the company distributed £377m in cash to shareholders via dividends. 

These numbers indicate to me that Carillion was running short on cash even before the string of profit warnings. Now that the company is in crisis mode, the cash situation is only going to become worse. Investors should avoid the business in my view. 

Profiting from global growth 

As Carillion struggles to remain afloat, recruitment company SThree (LSE: STHR) is pushing ahead. Over the past five years, SThree’s pre-tax profit has nearly doubled.

The company recorded healthy growth in overall profits and revenues in the six months to May 31. Profits before tax increased to £19.2m from £12.8m, while revenues climbed 7% to £521m. About 80% of its profits were generated outside the UK and Ireland indicating the group is an excellent play on the world’s improving economic outlook post-Brexit. Excluding the UK, where gross profits declined 16% year-on-year, gross profits at SThree were up 16% and 7% in the US and Europe respectively.

Unlike Carillion, SThree is a cash cow. In my view, cash flow is the most crucial part of any business, and this one certainly ticks all the boxes with a free cash flow of £64.2m for the past two years easily covering the dividend cash cost of £36m. At the time of writing, the shares support a dividend yield of 3.9% and trade at a forward P/E of 15. 

Overall, this global recruitment firm looks to be a much better buy than struggling Carillion. 

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Rupert Hargreaves owns no share 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.