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2 Neil Woodford stocks I wouldn’t touch with a bargepole

There are plenty of loss-making minnow stocks tucked away in Neil Woodford’s Patient Capital Trust and Equity Income Fund. I consider many of these far too speculative for my risk appetite. However, there are also a few stocks among his larger-cap holdings that I’m equally happy to avoid.

Roadside assistance firm AA  (LSE: AA) is one. Subprime lender Provident Financial (LSE: PFG) is another. Woodford owns 14% of the former and 25% of the latter. Here’s why these two stocks hold no appeal for me.

Company debts

AA’s private equity owners milked its cash flows, loaded it with debt and then sold it through a stock market flotation in 2014. Woodford participated in the 250p-a-share IPO, and in a further fundraising at 385p the following year. The rationale was that AA could use its “utility-like” cash flows to pay down its debt and, in due course, reward investors with generous dividends.

However, the business has struggled, partly due to past under-investment by its previous owners. Net debt has only come down from £2.99bn at July 2014 to £2.67bn at July 2018. And with the share price having declined to 83p, the debt dwarfs the company’s market capitalisation of £509m. At the same time, the ratio of net debt to EBITDA (earnings before interest, tax, depreciation and amortisation), which was worryingly high to begin with at 6.9, has deteriorated to 7.4.

The board declared a maiden dividend of 9p for the company’s 2016 financial year, but has currently pegged it at 2p for the foreseeable future. This gives a skinny yield of 2.4%. Meanwhile, I view a forward price-to-earnings (P/E) ratio of 5.6 as only deceptively attractive, due to the £2.67bn debt, which equates to around 435p a share.

The company’s last half-year results failed to impress my colleague Paul Summers, or the wider market. A trading update is slated for a week today, but I’m steering clear of the stock for the time being — and for as long as its debt remains at such an elevated level.

Customer debts

Woodford has been a long-term backer of Provident Financial. The company has a market capitalisation of £1.32bn at a current share price of 523p. However, less than two years ago, the shares were comfortably above 2,000p. This was before a disastrous change to its operating model — and other problems — sent it crashing out of the FTSE 100.

One year and a rescue rights issue later, the company is still struggling. It issued another profit warning last month, ahead of 27 February results for its financial ended 31 December. Management said there’s been “some pressure on delinquency and arrears metrics” and that  “underwriting standards have been progressively tightened.”

Neither is good for growing the business, as tightened lending puts pressure on top-line growth and delinquencies hurt profits. With UK consumer debt at unprecedented levels, I think there’s high downside risk to earnings and dividend forecasts. This makes a 2019 P/E of 9.7 and forecast yield of 6.9% unappealing, in my book.

Finally, with the group’s Vanquis bank and Moneybarn car finance arm both under scrutiny by the Financial Conduct Authority, this is another Woodford stock I’m happy to avoid.

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G A Chester 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.