The share price of funeral-related services specialist Dignity (LSE: DTY) dropped by as much as 50% on Friday after it released a profit warning. A more competitive market outlook means that the company will cut prices for various services, which is expected to cause a fall in profitability over the medium term. As a result, investor sentiment has deteriorated.
However, the company could deliver a strong turnaround in the long run. A stable market, strong business model and low valuation could combine to make the stock a worthwhile purchase at the present time.
A changing market
In the last couple of years, Dignity has faced a more competitive marketplace. With inflation moving higher and now being ahead of wage growth, disposable incomes are falling in real terms. Therefore, it is unsurprising that consumers are seeking to cut costs in order to balance their income and expenditure each month. And while funeral costs are an exceptional item, they are not immune to increasingly price-conscious behaviour.
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Alongside increasing competition, the company has seen the average reduction in the number of funerals per location running at 6.8% between 2015 and 2017. This is almost twice the rate of 3.6% which was recorded between 2004 and 2014. In response, the company is lowering the cost of some of its services as it seeks to protect its market share. This is expected to lead to substantially lower profits in 2018.
Recovery potential
The level of profitability that is expected to be recorded in 2018 is unclear. As such, it seems as though investors are pricing-in a wide margin of safety. Dignity now trades on a price-to-earnings (P/E) ratio of just 8 using its 2016 earnings figure.
While its rating is very likely to rise due to the prospective fall in 2018 earnings, the reality is that the company continues to have a dominant position in the funeral services market. With it offering the scope for further growth in the long term, the stock could prove to be a sound, albeit volatile, turnaround opportunity.
Strong performance
Operating in the general retail sector is a more stable growth opportunity. Online takeaway ordering specialist Just Eat (LSE: JE) continues to perform exceptionally well following its promotion to the FTSE 100. Its shares are up 14% in the last three months and continue to offer growth at a reasonable price.
For example, the company is forecast to post a rise in its bottom line of 42% in the current year, followed by further growth of 30% next year. This puts it on a price-to-earnings growth (PEG) ratio of just 0.9, which suggests that it could offer continued upside potential.
Following the acquisition of Hungryhouse, Just Eat now has a more dominant position within its sector. This could lead to improved growth prospects, while its international diversity may mean that its risk/reward ratio remains attractive over the medium term. As such, now could be the perfect time to buy it for the long run.
