Are these battered FTSE 250 stocks ready to rally?

Updated: 
TalkTalk sign

Shares of TalkTalk Telecom Group (LSE: TALK) fell by 10% on Wednesday morning after the firm said it would cut the full-year dividend by 35% to 10.29p in order to reduce debt. The 2017/18 dividend will be set at 7.5p per share, a 50% cut over two years.

This move appears to have surprised the market, but I believe a dividend cut has been overdue for some time. TalkTalk's earnings have not covered its dividend payout since 2014, during which time net debt has ballooned from £497m to £782m.

As I've commented previously, this month's boardroom reshuffle was always likely to be the trigger for a cut. Chief executive Dido Harding has been replaced by Carphone Warehouse founder Charles Dunstone, who will serve as executive chairman, and former TalkTalk Consumer boss Tristia Harrison, who will be chief executive.

Time to buy TalkTalk?

Will today's dividend cut and Mr Dunstone's arrival mark a turning point for TalkTalk?

Dunstone said today that his priorities will be growth, cash generation and profit. TalkTalk's 2016/17 results suggest to me that the firm's performance is already moving in the right direction.

The group reported a net addition of 22,000 new customers during the fourth quarter, after a period of decline. Although revenue fell by 3% to £1,783m last year, adjusted operating profit rose from £131m to £165m. The group's underlying free cash flow improved from £82m to £110m.

The only fly in the ointment was net debt, which rose from £679m to £782m last year. That's too high for a company with pre-tax profits of £70m, in my view. However, I expect a steady reduction in borrowings, now that the dividend has been cut to a level at which it should be covered by free cash flow.

Looking ahead, TalkTalk trades on a 2017/18 forecast P/E of 11.5, with a prospective yield of 4.6%. This stock has gone onto my watch list as a potential turnaround buy.

This 6.5% yield looks tempting

Not all turnaround situations require a dividend cut. Management at department store group Debenhams (LSE: DEB) has so far been able to reduce debt levels and maintain the dividend.

As a result, Debenhams now offers a prospective dividend yield of 6.5%. Reassuringly, last year's payout was covered by both earnings and free cash flow. However, a further decline in sales is forecast for the current year.

The group's challenge is to make its stores a destination for shoppers, while supporting online growth. Plans are underway for a greater emphasis on beauty, food and drink, designer clothing and accessories like footwear and lingerie. These are intended to attract what the firm describes as "social shoppers", and to sit alongside an improved internet offering.

It's not clear to me how much growth potential Debenhams has. But it may be worth noting that while UK like-for-like sales only rose by 0.5% during the first half, online sales rose by 64%. This suggests to me that there's an opportunity to expand online.

Debenhams stock currently trades on a 2016/17 forecast P/E of 7.9, with a well-covered dividend yield of 6.5%. At this level, I think it's worth considering as a value buy.

Don't ignore these dividend champions

Investing in turnaround stocks with high dividend yields can be risky. The chance of a dividend cut is often quite high.

It can be more profitable to focus on successful companies with strong dividend growth rates. Such companies have the potential to provide inflation-beating incomes for many years.

Our experts have identified five big-cap stocks with massive income growth potential. If you'd like all the details, download 5 Shares To Retire On today.

This exclusive report is FREE and without obligation. To get your copy, just click here now.

Roland Head has no position in any 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.