Why I'd still sell Carpetright plc even after today's 40% discount

Among Friday's biggest fallers was carpet and floor coverings retailer Carpetright(LSE: CPR). Its share price traded at a 40% discount to its price at the previous day's close, with investor sentiment declining significantly in response to a profit warning.

Of course, difficulties for UK-focused retailers are not particularly surprising. With consumer confidence being low and inflation remaining stubbornly high, things could go from bad to worse for the company during the course of 2018.

Difficult period

Its trading during the key Christmas period was significantly worse than expected. Like-for-like (LFL) sales in the UK declined by 3.6% in the 11 weeks to 13 January 2018. This caused total sales to fall by 2.3%, with profitability for the remainder of the year set to be much lower than expected.

In fact, the company is now forecasting a profit in the range of £2m-£6m for the year. It would be unsurprising for this figure to be revised downwards, since there seems to be little scope for a sudden recovery in the coming months. Consumers are feeling the pinch of disappointing wage growth coupled with higher inflation. This means that purchases of discretionary items such as carpets and flooring are being delayed.

With Brexit talks ongoing and confidence in the UK's economic outlook being relatively low, it is difficult to see how the company's fortunes could improve in the near term.

Valuation

With Carpetright now trading at a major discount to its previous valuation, some investors may be tempted to buy it as a recovery play. While the company's international stores continue to deliver sales growth and its refurbishment programme may help it to compete more effectively against rivals, the fact is that it faces an uphill struggle in the near term.

Challenging trading conditions look likely to remain in play, and with margins set to fall, the company's share price could do likewise during the rest of the year.

Turnaround potential

Investors looking for a potential turnaround opportunity may be better off with RBS(LSE: RBS). While it operates in a completely different sector to Carpetright, RBS has also experienced a difficult period in recent years. Legacy issues, the cost of PPI and poor performance from some of its divisions have meant that its outlook from an investment perspective has been relatively uncertain.

However, the company now seems to have a bright future. It is forecast to generate earnings growth of 5% this year, followed by further growth of 8% next year. This puts it on a forward price-to-earnings (P/E) ratio of around 10.4, which suggests that it offers a wide margin of safety. This could mean that its downside risks are low and there is significant upside potential.

One possible catalyst to push the RBS share price higher is its dividend prospects. The firm is expected to raise the payout by 80% in 2019, which puts it on a forward yield of 5.3%. With dividends expected to be covered 1.8 times by profit, they could rise further in future years.

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Peter Stephens owns shares in RBS. 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.

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