Dignity plc isn’t the only cheap stock I’m avoiding

Roland Head explains why Dignity plc (LON:DTY) isn’t cheap enough to tempt him.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

sdf

When funeral service provider Dignity (LSE: DTY) crashed 50% in one day on 19 January, I was tempted. This historically profitable company now trades on a 2018 forecast P/E of just 10, with a well-supported forecast yield of 2.9%.

However, I’ve resisted the temptation so far, and in this article I’ll explain why. I’ll also highlight another stock I’m avoiding after recent news.

Falling market share

For some time, Dignity’s management has been happy to trade off a falling market share for higher profit margins. Between 2004 and 2014 this strategy worked well, with only a modest decline in market share. However, the rate of decline has almost doubled since 2015, forcing the firm’s management to start cutting prices.

Should you invest £1,000 in Cineworld right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Cineworld made the list?

See the 6 stocks

Management blames “an over-supplied industry” and “increasingly price-conscious” customers for these changes. But the reality is that businesses which generate unusually high profit margins always attract extra competition eventually, driving down these margins. I think the board has been complacent.

Uncertain profits

In its profit warning, Dignity’s management warned that it expects “substantially lower profits in 2018”. How much lower is uncertain, as the company plans to experiment to see how different price levels affect volumes and profit margins.

I’m also concerned about the group’s net debt of £520m. This is nine times 2018 forecast profit of £55.9m, and requires payments of about £33m each year. Although this will probably remain affordable, I think it will severely limit the amount of spare cash available for further acquisitions, limiting future growth.

I’m surprised that broker forecasts for 2018 have only been cut by an average of 17%. I’d have expected a reduction of 20%-30%. In my view, the risk of another profit warning is quite high. I plan to watch from the sidelines for now.

Just too big?

Until recently, I’ve rated cinema firm Cineworld Group (LSE: CINE) as an excellent growth stock with a successful business model. But the planned $5.8bn acquisition of US cinema chain Regal Entertainment has left the group at risk of indigestion, in my opinion.

To pay for the deal, Cineworld will issue £1.7bn of new shares and raise an extra £3bn in debt. The shares don’t concern me, as earnings from the enlarged group should easily offset dilution.

But extra borrowing means that the combined group’s net debt is expected to be four times earnings before interest, tax, depreciation and amortisation (EBITDA). That’s well above the 2.5 times level that’s often considered to be a sensible maximum.

There’s also a risk that Cineworld will struggle to achieve the same success with Regal’s US business that it’s managed in the UK. In fairness, the omens look good to me. Regal has a 20% market share in the US, where cinema attendance rates average 3.7 visits per year — one of the highest rates in the world.

It could work

Cineworld’s acquisition of Regal may well be an operational success. The group’s management does have a good track record. And with the stock trading on 12 times forecast earnings and with a 4.2% yield, there could be some value here.

However, I’m concerned about the level of debt required to fund this deal. Reducing this could put pressure on cash flow, so I’d like to see evidence that net debt is falling before I consider an investment.


Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head 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.

More on Investing Articles

Finger clicking a button marked 'Buy' on a keyboard
Investing Articles

5 strong reasons to consider buying Netflix for a SIPP or Stocks and Shares ISA

Our writer thinks that shares of the global streaming leader could make for a savvy long-term addition to a SIPP…

Read more »

British flag, Big Ben, Houses of Parliament and British flag composition
Investing Articles

£20k in an ISA? 2 top ETFs to consider from the London Stock Exchange

Whether it's high-yield dividends or growth, there are plenty of options on the London Stock Exchange to help build long-term…

Read more »

A GlaxoSmithKline scientist uses a microscope
Investing Articles

Up 20%! Here’s why Oxford Nanopore stock topped the FTSE 250 today

This under-the-radar growth stock in the FTSE 250 index just jumped to a 52-week high. Can it keep climbing higher…

Read more »

Man smiling and working on laptop
Investing Articles

Meet the penny stock that’s smashing Rolls-Royce shares in 2025!

Discover the penny stock that's taken Rolls-Royce's share price to the cleaners -- and see why its shares are still…

Read more »

Happy African American Man Hugging New Car In Auto Dealership
Investing Articles

Here’s what I’m expecting from Tesla stock as Q2 earnings approach

Tesla stock has recovered from its April lows. And as it leads the US Q2 earnings season, could this be…

Read more »

Two business people sitting at cafe working on new project using laptop. Young businesswoman taking notes and businessman working on laptop computer.
Investing Articles

Over the last 31 years, this index has beaten the global stock market by a wide margin

Looking to outperform a standard global stock market index over the long term? An ETF based on this index could…

Read more »

Investing Articles

Are we looking at a golden age for UK bank stocks?

UK bank stocks are on fire at the moment. Here, Edward Sheldon takes a look at what’s driving the enormous…

Read more »

A senior man and his wife holding hands walking up a hill on a footpath looking away from the camera at the view. The fishing village of Polperro is behind them.
Investing Articles

How much do you need in an ISA to target a £1,000 monthly passive income?

Discover how UK investors can target a large passive income in an ISA -- and one FTSE 100 growth share…

Read more »