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Should you snap up shares in fallers Micro Focus and Greencore Group plc?

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Micro Focus International (LSE: MCRO) has just seen its share price slashed in half. Known for years as one of the few companies actively supporting the COBOL language on modern computers, it puts a lot of its effort into providing software and support for legacy computer systems.

But the firm’s growth-by-acquisition strategy has hit a sticky patch, and some will be wondering if the success story is coming to an end. Unless the market has a short-term change of heart, Micro Focus looks set to drop out of the FTSE 100 come the next reshuffle. 

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The current problem stems from difficulties integrating HP Enterprise’s Software division, whose acquisition was completed in September 2017, and that’s hit the firm’s sales a lot harder than expected.

Bad fit?

As an ex-software developer myself, I was a little sceptical about the fit of the two companies’ businesses, with HP being a venerable behemoth and Micro Focus seen more as a nimble and more modern firm. And it’s starting to look like it might have taken on a poisoned chalice. 

Chief executive Chris Hsu’s departure after just six months also came as a shock.

Micro Focus was sitting on an adjusted net debt of $4.4bn at the halfway stage at 31 October, which is significantly more than its current market cap. For a company that’s been relying on an acquisition strategy that’s coming unstuck, that’s worrying.

Until recently I’ve been an admirer of Micro Focus, but I’m now fearing there will be more bad news before things get better, and I expect its mooted 7.4% dividend to be cut. For me, for now, Micro Focus is in bargepole territory.

Another crash

Convenience food manufacturer Greencore (LSE: GBC) suffered something similar, after issuing a profit warning on 13 March. In the days since, Greencore shares have slumped by 29%, and they’re down 55% over the past two years.

But unlike the problems at Micro Focus, I see Greencore’s troubles as being less deep and I can’t help feeling the sell-off has been overdone.

There are problems related to the under-utilisation of some sites in the US, and that’s led to a downgrade in the firm’s full-year EPS guidance. But it’s really only a modest reduction, with the earlier range of 15.7p-16.6p lowered to 14.7p-15.7p.

With the share price now down to around 131p, even the lower end of that guidance, 14.7p, still suggests a forward P/E multiple of only nine. On top of that, the forecast dividend of 5.9p per share would still be covered two and a half times, so I don’t see any immediate need to fear a cut.

Debt is key

Also, the share price drop has boosted the predicted yield to 4.5%, which I see as an attractive level.

My main caution, as so often, lies in the company’s debt levels. At year-end at 29 September 2017, Greencore was shouldering net debt of £519m, which was £187m worse than the same point a year previously.

That figure is a little over half the firm’s market cap, so it’s perhaps not that frightening. But it does amount to 2.7 times 2017’s EBITDA, and when that ratio gets above the 2 to 2.5 times range, I start to get twitchy.

Greencore could be a decent investment, but I see better alternatives out there with fewer red flags.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Greencore. The Motley Fool UK has recommended Micro Focus. 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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