Should you catch falling knives Essentra plc and Sepura Plc?

Essentra (LSE: ESNT) and Sepura (LSE: SEPU) have taken the unenviable title of London’s most prominent fallen angels this year. The two companies, which were once shining growth stars, have crashed back down to earth over the past 12 months, issuing a deluge of profit warnings and asking shareholders for extra cash. 

Year-to-date shares in Essentra are down by 54% and shares in Sepura have lost a staggering 89%. Unsurprisingly, these declines have attracted bargain hunters. 

According to TD Direct Investing’s ‘buy/sell’ indicator, which tracks the trading actions by investors using the company’s retail trading platform, the number of investors buying Sepura and Essentra on dips has far outweighed those investors selling during the same periods. 

But is this the right course of action? Buying when there’s blood on the streets can be a profitable strategy. However, the key caveats of investing still apply: you should only invest in companies with a strong business model, robust balance sheet and trustworthy management. 

Running out of cash 

Sepura has continually disappointed its investors this year and the company’s first-half results published today don’t break from form. 

Trading has remained slower than expected. The firm booked a pre-tax loss of €62.1m in the half year to the end of September, compared to a €6.2m interim profit a year prior as revenue halved from €92.9m to €43.4m. Management expects revenue for the full year to fall in the range of €125m to €135m, compared to €189.7m a year before.

Collapsing revenue is the least of Sepura’s problems. The company warned today that it’s reviewing a range of strategic options and will require a waiver of some of its lending covenants from March 2017, based on the bleak outlook for its current financial year. The company is in talks with Hytera Communications Corp about a possible takeover, but if these discussions fail, there’s a very real possibility Sepura could be forced into liquidation at some point over the next year. For this reason, it’s probably best to avoid the company. 

Yet another profit warning 

On Monday, Essentra issued its second profit warning of 2016. Weakness in parts of the group has continued into the second half of the year as management struggles to integrate manufacturing facilities acquired as part of the $455m buyout of Clondalkin Group in 2014. 

Essentra now expects to make an adjusted operating profit of £137m to £142m in 2016, down from its previous guidance of £155m to £165m. Still, these numbers are up significantly year-on-year. The company reported pre-tax profits of only £90m last year. And even on lowered guidance, City analysts expect the company to report earnings per share of  43.4p for the year ending 31 December 2016, which means the shares trade at a forward P/E of 11.4. Furthermore, unlike Sepura, Essentra appears to have no immediate funding concerns. 

So, if management can get Essentra back on track, the group might be an attractive recovery play although investors should bear in mind that profit warnings usually come in threes. I wouldn’t be surprised if the company warned on profits once more before the end of the year.