Support services and construction group Interserve(LSE: IRV) has been hammered by a run of bad news and profit warnings. Could now be the perfect time to buy the bombed-out shares or is the slump set to continue?
News of a contract win today has sent Interserve's shares up a couple of pence to 118p, continuing a recovery from a low of 74p on 14 September. Nevertheless, they remain down by 65% for the year to date.
The company is suffering a massive headache from exiting its Energy from Waste (EfW) business. A previous provision of £70m for incurred and anticipated losses was raised to £160m on 20 February and to "significantly" in excess of £160m on 14 September. The company's inability to accurately forecast the provision suggests that the complexities and uncertainties mean it has no real handle on the final costs.
As if this is not bad enough, there was further ominous news in the 14 September update. The company advised:"Trading in the UK in July and August was disappointing, particularly in support services, but also in the construction division. As a result of this, the board now believes that the outturn for the year will be significantly below its previous expectations."
While Interserve legitimately calls itself an international business, the UK totally dominates. It's currently contributing 90% of group revenue and 97% of operating profit at a skinny margin of 3.1%, while international's 3% contribution to operating profit is at an even lower margin of 1.2%.
Interserve's current market cap of £172m is dwarfed by this year's expected average net debt of between £475m and £500m. And while it has committed facilities of £573m and "continues to believe" it will be able to operate within its banking covenants for this financial year, I see serious downside risk. This is due to the EfW nightmare, the company's low profit margins, the ominous news on recent UK trading and the minimal impact from its international business. I'd want some visibility on the outlook before considering making an investment.
Signs of recovery
I see a clearer outlook and investment case for exhibitions group ITE(LSE: ITE), whose shares are up 6p today at 184p after a trading update for its financial year ended 30 September.
The company has struggled for a few years, without plumbing the depths of uncertainty of Interserve, and is now showing signs of recovery. Its shares are up 20% so far this year.
In today's update, management said it expects to report a 13% increase in revenue and a first year of underlying like-for-like growth in four years, despite challenging conditions in some of its markets. The £495m cap firm also said today that its financial position continues to strengthen, with strong cash conversion helping to reduce net debt to £50m from £59m last year.
ITE's broad spread of international revenues is serving it well, as is its strategy of focusing on its core high-yielding, market-leading events, and implementing a sales performance culture. Management expects to deliver mid-term sustainable operating margins in the high 20s.
Although it's trading on over 20 times earnings, I see potential for earnings upgrades and for the company to rapidly grow into the rating. On this basis, I rate the stock a 'buy'.
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G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended ITE Group. 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.