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A ‘secret’ small-cap recovery stock I’d buy today, and one I’d avoid

When I looked at Mothercare (LSE: MTC) in May, the share price was on a surge after encouraging full-year results. But I still saw a need for caution. That caution appears justified, as Mothercare shares are down 11% so far Friday on the back of a disappointing first-quarter update.

The shares had already been giving up some of their recent gains, having fallen back from a 24.6p peak in June. The latest drop puts them down at 17.5p.

Tough trading

Mothercare has downgraded its medium-term outlook for the UK, suggesting the market “will continue to be uncertain and volatile, accompanied by fragile consumer confidence.” As a result, “gross margin improvements in the UK are expected to take longer to materialise than previously anticipated.

Underlying pre-tax profitability for the current year looks set to come in at similar levels to last year — when the firm recorded a statutory pre-tax loss of £66.6m, and an adjusted loss of £20.4m. To help with the longer time now expected for the company’s recovery, lenders have agreed to a temporary deferral of planned loan reductions.

I’m convinced we’ll still need to be cautious for some time to come. I think it could easily take another couple of years to see the shape of a hopefully-recovered Mothercare and to have enough information to work out some sort of rational valuation for the shares. Right now I can’t do that, and I’m sticking to my rule to never buy a recovery stock until after it’s recovered.

Growth plus income

By contrast, Speedy Hire (LSE: SDY) looks like a recovery that’s actually happened. Last November, Kevin Godbold re-examined the firm and saw both dividend and growth prospects. Since then, the share price has been erratic and has dipped a little overall, so did he get it wrong?

No, I think it’s the market that’s missing a trick here, possibly because our Brexit-led uncertainty is driving investors to seek mega-cap safety. And that can leave bargains for those of us willing to take a little risk. The industrial equipment hire firm’s last set of results in May showed strong figures across the board, with adjusted EPS up 21% and the dividend lifted by the same proportion to provide a 3.7% yield.

Rising dividend

With double-digit EPS growth on the cards, forecasts suggest a dividend yield of 3.9% for the current year and 4.4% next. And with P/E multiples dropping to under 10 and the company showing attractive PEG growth characteristics, what’s there to fear? I’ll sound two notes of caution.

One is that net debt has built up a bit, reaching £89.4m (from £69.4m a year previously). That’s still less than 1.2 times EBITDA, and I don’t see any major concern on that measure alone. But my second concern is that the business is typically cyclical. So a lower-than-average P/E is probably appropriate, and I wonder if debt might become an issue in any future down cycle.

All in all, though, I’m seeing Speedy Hire as an overlooked buy right now, and it’s on my shortlist.

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Alan Oscroft 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.