A small-cap recovery stock I'd buy ahead of Carillion plc

Bad news can see a share price crushed to over-pessimistic lows, yet it can bounce back quite quickly.

Sadly, that wasn't the case with Carillion(LSE: CLLN) after its share price slumped following July's profit warning. While the support services provider and construction contractor might have looked like a tempting recovery prospect, the bad news continued and a further warning on 17 November created fresh panic.

The firm's outlook had deteriorated further and it revealed it was set to breach its banking covenants unless it could delay the scheduled tests -- prior to that, Carillion had told us it was forecast to be in compliance with those covenants at year-end in December.

Looking at its fundamentals now, with the share price down to 17p (which represents a 93% fall in 12 months), the P/E is crushed to almost nothing -- although forecasts are not worth a lot right now, as the firm's very existence is under threat.

Debt is the killer

Net debt stood at £571m at 30 June, almost double the £291m level a year previously. That's the equivalent of more than three times last year's underlying pre-tax profit, and that multiple should rise significantly based on this year's results. Debt is now nearly five times the currently forecast pre-tax profit for December 2017, and I think even that could turn out to be optimistic.

And with the firm's market cap at just £71m at the moment, it's effectively owned many times over by its creditors.

Carillion is in a highly competitive industry, with relatively low margins and a slowdown in demand. I can't see how it's going to pull this one out of the fire.

A more attractive prospect

Negotiating its way out of a tricky debt situation is also a key strategy at HSS Hire Group(LSE: HSS) at the moment, with the tool and equipment hire company having suffered from a few tough years. And pre-tax losses are forecast for the next two years, albeit a relatively small one of £3.3m for 2018.

The share price has crumbled too, by 85% over the past five years to 29p, though it has ticked up today by 5% after the company released a third-quarter update -- which did suggest things are finally turning round.

The firm's services business appears to be the highlight at the moment, with a 12% rise in revenues, and Q3 profits were reported to be ahead of the first half, in line with management expectations. In fact, HSS has now recorded five successive months of EBITA profit.

Cost-saving measures are "fully implemented" and should result in annualised savings of around £13m, and HSS reckons its improvements in capital efficiency should lead to £4m-£6m in capital reduction year-on-year.

It's debt again

The firm's net external debt figure of £232m might cause a sharp intake of breath -- it's down from £240.4m at the same stage a year ago, but it's still a big figure for a company with a market cap of £50m.

It's a risky investment for sure, and the key will be debt renegotiation due next year. But with the company's turnaround gathering strength, I'm less concerned about that than I am over Carillion's situation. I seriously doubt the banks will pull the plug at this stage -- especially if we get closer to a forecast return to profit.

I'm cautiously optimistic.

More small-cap potential

An investment in HSS certainly carries risk, but there are some safer growth candidates out there. This free report from the Motley Fool's top analysts examines one such rapidly-growing company in detail, and I definitely reckon it's worth a closer look.

It's a UK-based business in an established market, so there's less of the risk that can beset some smaller companies. And it's been steadily growing its earnings for years and lifting its dividends nicely too.

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Alan Oscroft has no position in any of the 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.

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