Why I’d avoid these Neil Woodford stocks at all costs

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Shares in Neil Woodford’s favourite roadside assistance company AA (LSE: AA) are plunging this morning after the company published a strategy update, confirming that it is cutting its dividend and profit expectations for the full-year. 

According to the update, the group is now embarking on a strategy to increase its long-term viability, spending an extra £45m this year on growing the business by investing in 65 more roadside vans, to cut its reliance on third-party garages for callouts, expand its fledgling insurance division and convince more customer to take up its telematics technology, which enables customers to detect a problem before it happens.

To fund this expansion, the company has cut its dividend from 9p per share to 2p and now expects profit for the year to 31 January 2019 to be £335m-£345m, compared to the year ending 31 January 2018 of £390m-£395m. Following this dividend cut, shares in AA now support a yield of just 2.2%, down from around 9% before today’s statement. 

Further pain ahead

Unfortunately, I believe that it may not be long before the company has to cut its payout altogether. You see, ever since its IPO, AA has been haunted by its high amount of leverage, acquired during its time under private equity ownership. In total, the group has more than £2.7bn in net debt. When compared to profit forecasts, this colossal debt mountain looks terrifying, and it’s difficult to see how the business will ever be able to settle its obligations. 

With profits falling, it’s only going to become harder for management to invest in the business, return cash to shareholders and pay down debt. For this reason, no matter how cheap shares in AA become, I’m going to avoid it at all costs, or at least until it can get its debt under control. 

Struggling to produce returns

Another Neil Woodford stock I’m avoiding is Allied Minds (LSE: ALM). It invests in early-stage tech businesses, a risky and unpredictable strategy and one that the company is struggling to make work. Indeed, since its IPO in 2014, rather than creating value for shareholders, the firm has done nothing but destroy shareholder value with the stock falling from an IPO price of 190p to 143p today. 

Last year, shortly after new chief executive Jill Smith took the helm, the company announced a $146m writedown on the value of seven of its portfolio business, only a few months after asking shareholders for an additional £64m to fund new investments. 

Considering Allied’s record then, it might be wise for investors to stay away from the business. That being said, investing in early-stage companies is risky but rewarding if you get it right. Even though Allied has failed to generate any value for shareholders over the past few years, the next Facebook could be sitting in its portfolio today, and the returns from such an investment would be enough to wipe out years of losses. 

So, for high-risk investors, Allied might be suitable. However, personally, I prefer companies that have a proven record of creating value for shareholders just like the business profiled in this free report. 

Our experts believe this well-known FTSE 250 growth stock has the potential to grow its market value from £1.3bn to £4bn over the coming years, suggesting a gain of up to 200% might be possible for investors. It has already doubled earnings per share over the past five years.

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Rupert Hargreaves does not own shares in any company mentioned. The Motley Fool UK owns shares of and has recommended Facebook. The Motley Fool UK has the following options: short March 2018 $200 calls on Facebook and long March 2018 $170 puts on Facebook. 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.