Is NCC Group plc a falling knife to catch after dropping 25% today?

Updated: 
FTSE 100 falling prices

Shares of cyber security firm NCC(LSE: NCC) crashed 29% to 126.5p in the last minutes of trading yesterday after the company issued a profit warning at 4.16 p.m. The rout has continued this morning with a further fall of 25% to 95p at the time of writing.

Is the news as grim as the market reaction suggests or is this a falling knife that could be worth catching?

Writing on the wall

I marked NCC as a stock to avoid after a trading update back in October when it said it had experienced a number of setbacks, including three large contract cancellations, a large contract deferral and difficulties with some other contract renewals.

Management said "growth in profitability will now be more biased towards the second half of the year than initially expected, but remains in line with the board's expectations". However, all too often in these situations -- where a company has a disappointing first half but says it will make up the lost ground in the second half -- a profit warning ensues.

NCC was on a forward P/E of 18 at the time (share price around 220p) and I suggested there was potential for the shares to fall a lot further should we see the toxic combination of a profit warning and the market deciding the company merits a lower earnings rating.

Double whammy

NCC issued a profit warning in December and yesterday's late afternoon release was more serious still. The board not only downgraded full-year adjusted EBITDA guidance to approximately 20% below the already-lowered £45.5m to £47.5m range, but also said it's initiating a comprehensive strategic review, which will be supported by externally appointed consultants.

Goodwill not so good

At a current share price of 90p, NCC has a market cap of close to £250m. Adjusted EBITDA last year was £43.7m, while the mid-point guidance for this year is £37.2m (down 15%).

At the last balance sheet date (30 November), NCC had net debt of £48.8m. A net debt to EBITDA ratio of 1.3 times is modest and with the company also having available borrowing facilities of £112.5m, compared with £65.9m utilised, lenders aren't going to be knocking at the door, which is obviously a good thing.

However, while NCC's net assets of £278m might look attractive at first sight, given the market cap of £250m, the company's aggressive acquisition strategy means that just about the entire £278m can be accounted for by goodwill. With the group now performing well below expectations, it looks like there will have to be some hefty goodwill writedowns.

Bottom line

Earnings uncertainty after two profit warnings leaves me disinclined to make a guess at what the forward P/E might end up being. On top of this, doubts about the value of acquisitions, likely goodwill writedowns and a major strategic review in progress (which the board has decided it needs outside help with), mean NCC remains a stock to avoid in my view. That's at least until the outcome of the review is known, which the company says will be no later than the annual results due in July.

Avoidable mistakes

Some investing mistakes are more avoidable than others. Avoiding the most common wealth-sapping mis-steps can make a huge difference. With this in mind the Motley Fool's experts have published a FREE report called The Worst Mistakes Investors Make.

This exclusive free guide won't cost you a penny and comes without any obligation. Simply CLICK HERE for your copy.

G A Chester has no position in any shares mentioned. The Motley Fool UK owns shares of NCC. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.