The FTSE 100 index rallied on Friday and is in positive territory on Monday after two volatile trading sessions last week.
Shareholders of AstraZeneca (LSE: AZN), Centrica (LSE: CNA) and Thomas Cook (LSE: TCG) are going to be in trouble if market volatility persists, in my view. Here’s why.
Astra/Centrica: So, When Will Suitors Show Up?
Astra operates in a sector that should be on the radar if volatility springs back, but its shares still price in an M&A premium in the region of 20%. Astra offers long-term value if management meet their (very) long-term targets. Do you have time to wait for them to deliver? In the meantime, risk is skewed to the downside.
Of course, both Astra and Centrica would deliver plenty of value if they were taken over. In fact, a change of ownership remains the main attraction for investors, in my view. As time goes by, however, shareholders may wonder if suitors will ever emerge with a solid offer.
While Astra stock is overpriced, the shares of Centrica are cheap as they trade around their two-year lows. Well, they are cheap for good reasons!
First, buybacks are unlikely to provide a fillip to Centrica’s equity valuation in the next few quarters. Second, the payout ratio is very likely to come under pressure. Third, the balance sheet is stretched, and cash flows are not reassuring. It’s also unclear why credit rating agency Moody’s hasn’t downgraded Centrica earlier this year, although it may be argued that successful disposals may help the company raise vital resources.
Thomas Cook: Low Profitability — But Is It An Opportunity?
Thomas Cook recently said that 2014 earnings before interests and taxes (EBIT) is expected to be between £315m and £335m.
The group’s EBIT is expected to grow at an annual clip of 20% to 30% in the next couple of years, but even then Thomas Cook will be only marginally profitable after interests and taxes are paid. Operationally, Thomas Cook has become more efficient, true. Financially, its positions remains problematic, however.
Net debt declined to £421 million in 2013 from £788m in 2012, and Thomas Cook now expects its net debt position to drop to between £300m and £350m this year as working capital swings should become more predictable.
Based on trading multiples, its shares trade in bargain territory, but are highly volatile. Underlying margins are thin, which means that if Thomas Cook doesn’t meet its growth forecast, it will struggle to remain profitable over time. In stable market conditions, Thomas Cook stock could easily trade in the 140p-160p range (it’s currently priced at 118p).Â