Not all companies trading on low valuations are the bargains they appear to be. Take battered construction and services firm Carillion (LSE: CLLN). Despite only trading on a price-to-earnings (P/E) ratio of just two for the current year, I wouldn’t go anywhere near the stock, despite recent developments.
To recap, last Tuesday the company revealed that it had agreed new credit facilities and deferrals on some of its debt repayments. In addition to this, the £200m cap announced the sale of most of its UK healthcare business to outsourcer Serco — a business that’s also had its fair share of problems over the last few years — for just over £50m.
Is this sufficient? Hardly. Let’s not forget that the small-cap booked an £845m writedown of construction contracts back in July. Tackling the amount of debt on the company’s books will take a while, during which time loyal holders of its stock won’t get so much as a sniff of a dividend. When you’re not even being paid to be patient, you really have to question whether a business is truly investable.
Yesterday’s announcement that the company had recruited ex-BAE Systems executive Andrew Davies as its new CEO may have been welcomed by market participants, but few would disagree that he faces an unenviable series of tasks when he officially takes up his new role next April. These include continuing to dispose of Carillion’s assets, attempting to recoup money from historic contracts and overseeing a likely share placement.
These facts, when coupled with the hugely unpredictable share price at the current time, suggest that the Wolverhampton-based firm should only appeal to traders or speculators and not those adopting the Foolish investment philosophy of buying quality companies at reasonable prices and holding them for the long term.
Carillion’s turnaround plan may have started, but I’m more than content to watch from the sidelines.
Troubled times ahead?
Despite the general resilience of the gambling industry during uncertain economic times and a recent rise in operating profit, another stock I wouldn’t go near right now would be bookmaker Ladbrokes Coral (LSE: LCL). Like Carillion, the newly-merged company carries a lot of debt on its balance sheet. Moreover, the sheer amount of competition it faces from other established high street players and online gaming companies ensures the amount of money spent on marketing and promotions must remain stubbornly high.
But high levels of debt and a hyper-competitive market aren’t the only problems for Ladbrokes Coral right now. New legislation on fixed odds betting terminals could soon have a huge impact on the company’s level of profitability, more so than other bookmakers such as FTSE 100 constituent Paddy Power Betfair, which has a smaller high street presence. Should the government agree to drastically reduce the maximum permitted stake on FOBTs from £100 to £2, as suggested by the Campaign for Fairer Gambling, it doesn’t feel completely unreasonable to suggest that the £2.4bn cap may need to quickly re-evaluate its dividend policy.
With so much uncertainty, I believe investors may better off waiting for the outcome of the government’s triennial review (due any day) before deciding whether the shares are a safe bet. A P/E of 10 times is undeniably tempting but I would suggest that the shares are cheap for a reason.
Make no mistake
Buying cheap-looking companies on the expectation that their share prices will surely rise is a classic investor error.
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Paul Summers 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.