Shares in smoke alarm manufacturer Sprue Aegis (LSE: SPRP) fell by 45% to 142p this morning, after the AIM-listed firm issued a double profit warning. The firm's guidance for both 2015 and 2016 profits has been cut, causing the shares to crash.
2015 profits hammered by claims
Sprue Aegis says that a quality issue has been found with the batteries fitted to some of its alarms. It seems that these batteries won't last as long as they should. Most modern smoke alarms are sealed with a guaranteed lifespan. As a result, Sprue expects a surge of warranty claims triggered by low battery alarms sounding within the warranty period.
The firm said today that it's increasing its provision for 2015 warranty claims by £5.5m to £6.8m, up from just £0.9m in 2014. As a result, the firm's adjusted operating profit for 2015 is expected to be £7.3m, down from previous guidance of £12.1m.
My estimates suggest that this could result in 2015 earnings of about 13p per share, down from previous forecasts of 22.6p per share. If I'm right, then today's fall leaves Sprue trading on a 2015 forecast P/E of about 11.
If 2016 trading was going well, then this might have been a good buying opportunity. Unfortunately, 2016 is shaping up to be a bad year for Sprue Aegis.
2016 looks grim
Although it hand't yet published its 2015 results, today's trading statement covered the first quarter of 2016. Sales have fallen significantly below expectations in France and Germany. French sales surged last year, after a change to the law required all homes to have at least one smoke alarm. However, French retailers now appear to have been left with surplus stock they can't shift.
In Germany, the firm says that "product certification delays" on new models are responsible for weaker sales and these two factors are expected to result in Sprue Aegis reporting an operating loss of £1.9m for the first half of 2016.
Although the group expects to return to profit during the second half of this year, full-year sales are now expected to be just £55m, down by 22% from previous broker forecasts of £70m. Full-year operating profit is expected to be just £1.9m, down from £7.3m in 2015.
Is Sprue a recovery buy?
Sprue Aegis said today that it still plans to pay a final dividend for the year ending 2015. However, the dividend outlook for 2016 seems very uncertain to me. I suspect the payout will be cut or cancelled.
Despite this gloomy outlook, it's worth remembering that Sprue ended 2015 with net cash of £22.4m. It has historically been a well-run company and two of the firm's directors -- Chairman Graham Whitworth and Managing Director Nicholas Rutter -- are major shareholders, with a combined 13.8% of the shares.
Sprue doesn't seem to be in any danger of financial distress. Most of the problems announced today sound to me like one-off issues that should be resolved within 12 months. I think Sprue could be a good recovery buy at some point, but I think it would be wise to wait and see if things really do improve later this year before deciding whether to invest.
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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.