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Is Interserve plc now a classic ‘value trap’?

Shares in Interserve (LSE: IRV) have crashed on no less than three occasions this year after announcing two profit warnings and management finally admitting that it was in danger of breaching its debt covenants. With the shares now trading on a ridiculously low price-to-earnings ratio of just two, surely the stock has the hallmarks of a classic value trap? Well, I thought so too, but now I’m having my doubts. Read on to see why.

Annus horribilis

The management team over at Interserve probably can’t wait to see the back of 2017 – it’s been a truly horrible year for the international support services and construction group. In this ‘annus horribilis’ for the poor old bosses at the beleaguered firm, they’ve watched in horror as investors have exited in their droves to leave the company’s share price decimated after a long and painful 12 months.

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Back in February the Reading-based group saw its shares tank as it announced that the anticipated loss from its Energy from Waste (EfW) business was likely to cost £160m, as opposed to the much lower estimate of £70m given the previous year. The markets sliced a third off the company’s value the same day. A week later, and to no-one’s surprise, Interserve shelved its dividend. But that was just the start.

Profit warnings

The shares were to take another tumble in September, when the group gave the first of two profit warnings. Management said that it now expected the outturn for the year to be significantly below previous expectations following disappointing trading during July and August. The share price halved.

A second profit warning in as many months came along on 19 October, with management this time saying that it now expected operating profit in the second half to be approximately half that of 2016. This was accompanied by the revelation that the company was in danger of breaching its debt covenants, and that it was “engaged in constructive and ongoing discussions with its lenders“.

Hollywood disaster movie

But this story has more twists and turns than a Hollywood disaster movie. The very next day Interserve announced a five-year, £227m facilities management contract with none other than the UK government’s Department for Work and Pensions (DWP). And to put another spanner in the works, three days later the group said that it had secured a £140m contract extension with the BBC, until 2023. Now that doesn’t sound like a company that’s likely to cease trading anytime soon.

At around 80p, Interserve is now trading at a massive 90% discount to where it was less than four years ago at 745p, and those who like to view the glass as half full might see the recently awarded contracts and ongoing discussions with its lenders as a reason to be optimistic. Personally, I think the pendulum has just swung in favour of a value play rather than a value trap, and if I’m right there could be huge upside potential. But I must stress, this one is for diehard contrarians only.

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Bilaal Mohamed has no position in any 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.

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