Shares of FTSE 250 funeral group Dignity (LSE:DTY) are down by 17% at the time of writing on Friday, after the Competition and Markets Authority (CMA) said it would launch an investigation into funeral pricing.
The two areas of concern identified by the CMA are “how prices have changed over time” and “whether the information provided by funeral directors on prices and services is clear enough.”
A problem for Dignity?
Dignity shares fell by 55% in January after the group admitted it was losing market share and would have to slash prices to remain competitive.
Anecdotal evidence suggests that Dignity funerals are often more expensive than equivalent packages from independent funeral firms. The company’s figures show that its market share has been falling since at least 2004, but that this decline has accelerated since 2015.
Management propped up profits by raising prices and making more acquisitions. But this approach no longer seems sustainable. Analysts expect earnings to fall by about 40% this year.
The right time to buy?
January’s share price crash might mean that the stock is a contrarian buy. But I’m not convinced.
Firstly, I believe the company has too much debt. Net debt was £516.9m at the end of 2017, almost nine times after-tax profits of £57.8m. For a defensive business like this, I’d normally consider four times profits to be a prudent maximum.
Secondly, I don’t think that Dignity shares are cheap enough yet. Broker forecasts for 2019 put the stock on a forecast P/E of 17, with a prospective yield of 2%. For such a low-growth business, I’d want to see a P/E of less than 12. I’d continue to avoid this troubled firm.
Timing is everything
I’m more optimistic about the outlook for Sirius Minerals (LSE: SXX). Although the potash miner isn’t expected to produce any polyhalite until at least May 2021, it does seem to have the potential to become a highly profitable long-term business.
However, I wouldn’t rush to buy the shares at their current price. Before investing, I often like to look at a stock’s share price chart. What this shows for Sirius is that investors who have bought the dips on this stock have done pretty well. But investors who bought the peaks have done less well.
An investment at 20% in June 2015 has delivered a gain of about 70% in three years. That’s good, but not outstanding in a strong bull market. In contrast, buyers who picked up stock for 12p in February 2016 are already sitting on a profit of about 180%.
Wait for a dip
Sentiment towards Sirius is strong at the moment. But I believe another dip is likely at some point, as the market remembers the risks and long timescales of this project.
CEO Chris Fraser hopes to raise $3bn of debt this year to complete the project financing. As this cash is spent, I estimate that the enterprise value (market cap plus net debt) of Sirius Minerals will rise from around £1.5bn to about £3.7bn, even if the share price remains flat.
I think this is a fair valuation for this business at the moment. We are still several years away from production. Problems and delays may arise, and market conditions for fertiliser may not be so favourable when production finally begins.
To buy Sirius today, I’d be looking for a share price of no more than 25p.
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Roland Head 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.