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This FTSE 250 stock just crashed 30%. Here’s what I’d do now

A profit warning sent shares in SIG (LSE: SHI) crashing 30% during Thursday morning trading, and came just three months after a similar previous crash in October 2019 pushed the shares down 25%.

Back then, it was also a profit warning that caused the drop, and I mused on the wisdom of buying the shares for recovery — after all, when we see this kind of slump, it’s often an over-reaction and there can be nice profits to be had.

But I’ll never buy immediately after such a warning, as the collapse of Thomas Cook showed just how easily a bad situation can turn a lot worse, and I reckon it’s best to wait until there’s clear sign that the crisis is over.

As it happens, as of Wednesday’s market close, SIG shares had been up 35% on October’s trough and it was looking as if I’d missed an opportunity, but I’m obviously glad I passed on it.

Recovery delayed

The problems for SIG, which supplies specialist materials to the building trade, stem from weakening construction markets in the UK and in Germany, and the recovery steps announced back in October included the disposal of its Air Handling and Building Solutions divisions. But there was also a significant debt problem, and a company’s optimistic prognostications frequently turn out to be a little too bullish.

That’s what’s happened now, and against a background of “ongoing deterioration during the year in the level of construction activity in key markets,” and key indicators apparently suggesting things are going to get worse, it now seems the recovery is going to take longer than earlier optimism suggested.

SIG says of the measures instigated as a result of October’s warning that they should now be “delivering financial benefit in 2020, not in 2019 as previously expected.”

Profit downgrade

That’s going to leave this year falling significantly short of previous expectations, with the company now anticipating underlying pre-tax profit of around £42m — way short of analyst forecasts, which were indicating a little over £54m.

So, what would I do about SIG now? If we assume EPS will fall short of expectations by the same proportion as pre-tax profit, even at the current price, we could still be looking at a P/E as high as around 18 — the premature price recovery since October does seem to have pushed the shares up dangerously high in the circumstances.

Then we have SIG’s debt situation. The Thursday update told us that reductions in working capital have helped get net debt down to approximately £162m, from £189m at the end of 2018.

Still too expensive

To me that’s still dangerously high, and I’m surprised there’s still a dividend of 3.4p per share on the cards. Likely cover is probably down to around 1.5 times now, and I’d prefer to see the cash being used to attack that debt.

Holding debt, particularly if its cost is modest, can gear up profits during good times. But it can complicate the downside risk when markets are challenging, and I increasingly see it as an indicator to stay away. Combining that with not considering buying until turnaround expectations become reality means I still wouldn’t touch SIG shares.

And of course, I want to be sure the profit warnings have stopped.

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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.