Sometimes it makes sense to stick to what you know best. That seems to be the thinking behind today’s decision by Greencore Group (LSE: GNC) to sell its US business and focus on its larger UK convenience food business, which sells products such as pre-packed sandwiches and ready meals.
In fairness, the firm does seem to have been offered a good price for its US operations. The $1,075m (£817m) sale price equates to 13.4 times the group’s earnings before interest, tax, depreciation and amortisation (EBITDA).
Shareholders are set to receive a special dividend of 72p per share, although this depends on the group’s lenders agreeing certain refinancing arrangements.
Greencore stock has been wobbly this morning, perhaps because investors are surprised at the group’s strategic U-turn. The US market was meant to be its big growth opportunity. Less than three months ago, management said it was focused on this “large and structurally growing” market.
Defensive stocks such as Greencore and FTSE 250 meat-packing firm Cranswick (LSE: CWK) have been popular with investors in recent years. But as I’ll now explain, I think these stocks could see further falls over the coming months.
Greencore’s profit margins have been falling. In 2016/17, the firm’s UK operating margin fell from 8.3% to 7.4%. During the first half of the 2017/18 financial year, the firm’s UK operating margin was just 6.4%, down from 6.8% during the same period last year.
UK sales rose by 7.2% during the first half of this year, but falling margins meant UK profits only rose by 0.6%. I don’t want to overpay for a business that seems to be struggling to pass on rising costs to its customers.
The situation seems safer at Cranswick. Profit margins have improved in recent years and the group now generates an impressive 18% return on capital employed. However, earnings per share are only expected to grow by about 7% per year between 2018 and 2020. Is this growth business reaching maturity?
With US growth stripped out and UK profit margins falling, Greencore’s forecast P/E of 13.5 seems ample to me.
I’m cautious about Cranswick. Given the modest forecasts for earnings growth, the stock’s forecast P/E of 20 and 1.9% yield seem quite demanding.
Cranswick’s share price has already fallen by 15% this month. Despite this, I think changing market conditions could mean that the share price is still too high.
Rising rates could hit dividend stocks
If interest rates continue to rise, then the yield on bonds — such as corporate debt — are also likely to rise. In turn, this could mean that stock investors demand higher yields from dividend stocks.
Although fast-growing firms may still attract high valuations, companies with more modest growth rates could see their shares fall.
I think there’s a risk that Greencore and Cranswick could be affected. To earn a 3% dividend yield from Cranswick would require a share price of less than 1,900p. That’s 35% below today’s price. At Greencore, a 3% yield would knock another 5% off the stock’s value.
I’m attracted to the defensive qualities of both companies. But I don’t want to pay too much for their shares, so I won’t be investing today.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Greencore. 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.