Capita plc isn't the only stock I'm avoiding
Sports fashion retailer Sports Direct International(LSE: SPD) has seen its share price plunge around 50% since the end of 2015 but today's interim results are encouraging with revenue up almost 5% compared to a year ago and underlying earnings per share jumping almost 33% higher.
Recovery and up-trading
City analysts following the firm expect earnings to post gains close to 42% for the full year to April 2018, and 13% for the year after that, which suggests the underlying business could be recovering after a couple of years of falling earnings. The company's strategy aims to shift the retail proposition higher up the market by opening a new generation of stores and developing "elevated sports and lifestyle space."
In these results, Premium Lifestyle revenue shot up almost 66% over last year, which sounds like solid progress with the strategy. However, the division still only amounts to 4% of total revenue so there's a long way to travel before Sports Direct realises its ambitions. Yet I can't argue with its progress on earnings, which is backed by an almost 17% lift in free cash flow.
I'm not keen on the 159% rise in net debt to almost £472m since April. The directors put the rise down to "continued long term investment in strategic relationships", which is fine, "the high street elevation strategy", which is also fine, "and the share buyback programme", which doesn't benefit the underlying business. I think it's questionable whether any firm should be buying back its own shares when it still has debt. Maybe the cash would have been better spent paying down borrowings.
Nevertheless, I think the firm's business turnaround could have legs. But with the forward price-to-earnings ratio hovering close to 21 for the next trading year, and zero dividend, I think the valuation is ahead of itself so I will watch from the side lines.
Big yield, sliding share price
Over the past two-and-a-half years, investors in outsourcing specialist Capita (LSE: CPI) have endured a 68% plunge in the share price. I last wrote about the firm in October when the stock was at 561p. Sadly since then, the price has slipped to around 410p, down around 12% as I write today following the release of this morning's pre-close trading statement. It looks like my concerns about the company's lack of growth are playing out.
The statement contained a mix bag of news with a profit warning in the middle regarding the Private Sector Partnerships division: "We anticipate a higher level of contract and volume attrition which, subject to mitigating actions on sales conversion and costs, could impact upon the performance of the division in 2018". The firm also warned that the end of two major software licences in the second half of 2016 will likely "result in a decline of profits in the Digital & Software Solutions division".
Today's market is not one that ignores profit warnings and stock reactions can be brutal. City analysts following the firm expect earnings to tumble 14% this year and to bounce just 3% during 2018, so where's the incentive to buy the shares? You could load up to harvest the dividend. The forward yield now sits just over 7.6% for 2018, but that's in dangerous territory, especially when you consider that predicted forward earnings cover the prospective payment just one-and-a-half times. There's not much room for manoeuvre, so if further operational challenges come along the dividend could be vulnerable. Safer dividend yields are available on the London stock market, so I'm avoiding Capita.
Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended Sports Direct International. 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.