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Cheap shares: 2 more value traps to steer clear of in 2021!

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Since the Covid-19 pandemic caused a spring market meltdown, I’ve been bottom-fishing in the FTSE 100. My goal is to identify cheap shares in quality companies whose share prices have been smashed and set to recover. There is no shortage of candidates, as 55 FTSE 100 shares have dropped over the past 12 months. The average decline among these 55 fallers is 15.2%, but 21 stocks have performed worse than this average. That’s where I’ve recently concentrated my search for fallen angels.

Cheap shares: Is IAG a value trap?

At #100 on my list is the Footsie’s worst performer in 2020, the shares of International Consolidated Airlines Group (LSE: IAG). Over the past year, the IAG share price has more than halved, falling 55% in 12 months. That’s because IAG owns several airlines, including British Airways, Iberia, and Aer Lingus. As airmiles flown collapsed in early 2020, the IAG share price duly followed suit. At their 52-week high on 17 January, IAG shares exceeded 453p. At their low on 25 September, they had crashed to 86.54p, hurling them into the FTSE 100’s ‘cheap shares’ bin.

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As news of three efficacious Covid-19 vaccines emerged in November, the IAG share price soared like Concorde. By 4 December, it had surged to 178.8p, more than double its September depths. As I write, the IAG share price hovers around 163p — yet I see nothing to underpin the current share price except hope. No dividends, heavy losses for the foreseeable future — and a long, hard path to profitable airline travel in perhaps 2023–24. That’s why I see these ‘cheap shares’ as a classic value trap, so I would avoid IAG stock in 2020–21.

Melrose Industries: Value trap #2?

The second of my cheap shares/value traps is engineering conglomerate Melrose Industries (LSE: MRO). Melrose operates similar to a private-equity buyer, in that it “buys good manufacturing businesses with strong fundamentals whose performance can be improved“. Using low levels of leverage, Melrose buys, improves, and then sells businesses, returning these profits to shareholders. For the past decade, Melrose stock was great to own — until 2020 and Covid-19 arrived. Over the past year, Melrose share price has dived 29%, relegating the firm to #93 among FTSE 100 fallers over the past year. But I don’t believe these shares are cheap today.

At today’s share price of 159.7p, Melrose is worth £7.9bn, but that’s roughly what it paid to acquire GKN in 2018. Melrose operates in several sectors, but is strongly exposed to the automotive and aerospace industries, which are going through the wringer right now. As with IAG, for Melrose to recover, it needs a return to profitable air travel — and it might be two or three years before it can improve and sell GKN. Like IAG, Melrose cancelled its dividend earlier in the year, plus it has £3.3bn of net debt. Despite losing £685m in the first half of the year, Melrose should make a profit in 2020. But with earnings unlikely to return to pre-Covid-19 levels before 2023, these cheap shares just aren’t for me. They might well turn out to be a value trap, so I’d avoid them in 2020–21.

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Cliffdarcy has no position in any of the shares mentioned. The Motley Fool UK has recommended Melrose. 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.

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