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Why I’d buy this turnaround stock ahead of Provident Financial plc

Trading at over 3,200p as recently as May, shares of subprime lender Provident Financial (LSE: PFG) imploded spectacularly in the wake of two profit warnings. They’re trading at around 880p, as I’m writing.

Has the market overreacted, giving the shares potential to make strong gains for investors today, or is Provident a stock to steer clear of?

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Some merit in the bull case

The profit warnings were due to problems in Provident’s consumer credit division, which last year contributed £115m (33%) to group profits. A change of operating model from self-employed doorstep agents to full-time ‘customer experience managers’ aided by technology hasn’t gone smoothly. The company warned in July that the division’s profit this year would be down to £60m and then, just a month later, that it would make a loss of between £80m and £120m.

The chief executive has departed and the company reported last month that the consumer credit division has been stabilised under a new leadership team. This news prompted my Foolish colleague Alan Oscroft to argue that the shares are undervalued. Despite the company also facing a Financial Conduct Authority investigation into one of its banking products, I see some merit in the bull case.

Changing scene?

However, while Provident has made hay since the financial crisis, I’m concerned that the scene is now set for growth to be harder to come by for subprime lenders. Consumer borrowing is at an all-time high, interest rates are rising and inflation is running well ahead of wage increases. Bad debts could be set to balloon and the company may have to tighten its credit standards (in fact, it’s already started to do so). On this basis, I’m avoiding Provident for the time being.

Positive outcome

Shares of software firm Tracsis (LSE: TRCS), which specialises in rail and traffic systems and services, fell heavily in February. In a half-year trading update, the company said meeting full-year expectations was dependent on the timely conversion of new sales in the second half of the year and delivery of its gross margin improvement initiatives.

In these circumstances, the risk of a profit warning increases and it’s not always easy to judge whether the depressed share price is good value. In the case of Tracsis, the outcome has been positive. There was no profit warning and full-year results today actually came in ahead of market expectations.

Good growth prospects

The company posted revenue of £34.5m, a 6% increase on last year and £0.5m ahead of forecast. Adjusted earnings per share came in 4% higher at 24.08p, compared with a forecast 4% decline to 22.2p. It ended the year with cash of £15.4m (up from £11.4m at the end of the previous year) and no debt.

Management said: “The Group continues to hold a great position within our respective markets. Our financial strength coupled with favourable market conditions and good customer momentum provides a good platform for growth in the year to come.”

The shares are trading 4.5% higher at 522.5p, valuing this AIM-listed firm at £147m. The trailing P/E of 21.7 may look on the high side but with the cash pile representing 55p a share, the cash-adjusted P/E comes down to a more palatable 19.4. And with good growth prospects ahead, the shares look very buyable to me.

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended Tracsis. 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.