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Are these 2 crashing stocks unmissable buys, or falling knives to avoid?

Daily stock movements can be dramatic these days, mostly dominated by fallers. As of early afternoon, these two crashing stocks were heading Wednesday’s losers.

Rentokil Initial (LSE: RTO) fell 17% on the back of a trading update. As is becoming universal these days, a trading update is pretty much synonymous with a profit warning.

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Unable to provide us with actual outlook estimates, the business services firm said it is “impossible to predict with any degree of certainty the impact this will have, however, we do now expect a much more significant impact on our operations and performance in Q2 and beyond.”

Rentokil is the kind of ‘picks and shovels’ company that I think should be in big demand once we get out of this crisis, providing it can survive long enough. For that question, the balance sheet is critical, and the firm is taking drastic steps.

Too much debt?

Measures, which include pay cuts, scrapping bonuses, and scaling back marketing budgets should cut operating costs by around £100m in 2020. On top of that, discretionary capex has been suspended, as has the firm’s M&A programme. Oh, and dividends have been stopped too.

The firm reckons the net result will be a cash conservation of over £500m during the year. Will that be enough?

At 31 December, Rentokil’s net debt to EBITDA ratio stood at 1.8 times, which is getting into territory that sets me twitching. Anything over about 1.5 times makes me a little uncomfortable. The firm says its covenants would allow it to raise that as high as 4.0 times in certain circumstances, so it should be safe.

I did see Rentokil shares as overpriced, but perhaps not so much now.

Plunging stock

Waste disposal firm Biffa (LSE: BIFF) also released an update Wednesday. And it’s covering pretty much the same things.

Biffa’s fiscal year ends in March 2020, so the year just ending should be largely unaffected by the virus outbreak. But the firm said: “Given the rapidly changing dynamics in the external environment, it is extremely difficult to predict with any accuracy what the impact of COVID-19 will be on Biffa in FY21. It is however clear that the impact will be material and as such the group is not providing guidance at the current time.

It went on to stress its move towards cost reduction and capital preservation. Again, that includes putting a stop on non-essential capex, reviewing all areas of operating costs, and suspending the dividend.

Liquidity

On the liquidity front, Biffa has a recently renewed £350m revolving credit facility (RCF), which extends to March 2025. It says it expects to have combined available cash and RCF headroom of over £150m at the 2020 year-end this month. That’s close to a year’s underlying EBITDA, and it should hopefully be enough to see the firm through the crisis.

But at the halfway stage, net debt stood at £449.8m (albeit inflated by IFRS 16 rules). The firm reckoned that’s a pre-IFRS 16 net debt to underlying EBITDA ratio of 2.0 times, which sets my nerves on edge again.

I reckon both these companies will survive, and could come out of this as solid recovery candidates. But please listen up, company bosses. I’ve been banging on about the perils of debt for ages. This is why.

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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.