Good quality companies that have a long history of outperforming their peers can sometimes falter. Usually, this only happens when a big change, either cyclical or structural, takes place in the market. And when this happens, revenues and profits take a tumble, and so too do their share prices.
After a period of falling profits, some companies make a comeback, but many don’t. To determine which way a company is likely to end up, investors need to examine whether management is correctly identifying the issues that are behind the company’s weak performance and taking the appropriate action to rectify the problem.
With this in mind, I will take a look at whether these three underperforming FTSE 100 companies are still solid stocks.
Standard Chartered
Standard Chartered‘s (LSE: STAN) shares trade at a price-to-tangible book value of less than 0.5x, meaning its shares are valued at less than half of its net asset value. This reflects the market’s view that loan losses are expected to continue to rise and profitability margins will likely remain weak for some time.
Slowing growth in emerging markets are largely to blame, but there are other causes for the bank’s recent weakness. The bank had been over-reliant on investment banking profits and overexposed to lending in the commodities market and selected countries. But management is responding to this and has unveiled a new strategic plan, which seeks to shore up its balance sheet, cut costs and take a renewed focus on retail banking and wealth management.
This should help the bank to become leaner and more profitable, but near-term headwinds, including slowing economic growth and continued weakness in commodities markets, means profitability should remain weak in the medium term. In addition, investors are underwhelmed by management’s return on equity target of 8%, which the bank is only expected to achieve by 2018.
So, although its shares are cheap, they are cheap for some very good reasons.
Glencore
Glencore (LSE: GLEN), which has seen the value of its shares plummet 68% since the start of the year, has been finding it tough to adapt to lower commodity prices. When prices fell, the company initially chose to be inactive, and instead expected prices to recover quickly.
Unfortunately, prices continued to trend lower throughout much of the year, forcing Glencore’s management to eventually take much needed action to drastically reduce its indebtedness and restore profitability. It has stopped production from its loss-making copper mines in Africa, scrapped its dividend entirely and plans to raise another $2.5 billion in fresh equity. Accordingly, Glencore expects to cut its net debt by a third, to $20 billion by the end of 2016.
These actions seem to be the right steps in ensuring Glencore is profitable throughout the commodities cycle, but whether Glencore can stage a dramatic recovery very much depends on the commodity markets. Unless commodity prices, particularly copper and coal prices, rebound substantially from today’s levels, Glencore’s valuation is unattractive. Analysts expect underlying EPS will fall 57% to 5.9p this year, which gives its shares a forward P/E of 17.1.
Pearson
Education publisher Pearson (LSE: PSON) is being hit by a combination of cyclical and structural factors. Improving economic conditions has reduced the numbers of college enrolments in the US, leading to a reduction of textbook sales. And to make matters worse, changes in government education policies have reduced revenues for its examination services.
The company is facing structural change, too, with the transition from print to digital. But Pearson has already been proactive with the digital transition for a number of years now, with more than 60% of its revenues already coming from sales outside of printed materials.
Despite the recent worsening of investor sentiment, the outlook on earnings remains relatively positive. Analysts expect underlying EPS will rise 6% to 70.5p this year, which gives its shares a forward P/E of 11.8. And on top of this, Pearson’s shares have a prospective dividend yield of 6.5%.