Is Gattaca plc a falling knife to catch after dropping 10% today?

Today’s update from engineering and technology industries recruitment services provider Gattaca (LSE: GATC) has spooked the market and the shares are down 11% as I write.

Does that mean the new share price offers better value for investors or is the drop a warning sign that we should keep away?

Rising costs and delayed savings

The negative in the update is that the directors expect full-year profits for the year to 31 July to be 10%-15% below its prior expectations. There was no mention of missing expectations in the firm’s trading update for the six months to 31 January, which Gattaca delivered on 2 February, so I’m assuming that trouble emerged since then, suggesting a rapid deterioration, or maybe a sudden ‘realisation’.

The directors say that tougher UK trading conditions affected first-half performance after the Brexit vote, driven by “near-term uncertainty which led to elongated hiring decisions and some projects being delayed.”  However, that was known back in February. The new information is that costs have ballooned as the firm invests for growth and administration cost savings that were expected have been “delayed”.

The directors remain optimistic about the medium-term outlook, saying there are “some signs of a return of confidence in recent weeks.”

What kind of beast is Gattaca?

Recruitment firms are cyclical, and Gattaca’s shares are down about 57% from a peak of around 632p achieved during April 2014. Meanwhile, the price-to-earnings (P/E) ratio runs just over a low-looking seven or so.

When cyclical firms have low P/E ratings after a period of buoyant macroeconomic activity, it can often serve as a warning to investors that difficult trading could be on the way. I consider the shares to be dangerous right now, so I’m avoiding, rather than fighting the trend by buying.

Meanwhile, high technology tools and systems provider Oxford Instruments’ (LSE: OXIG) update today suggests the firm could be a better buy than Gattaca.

Growth expected

The company reckons its full-year results to 31 March will come in flat, so no earnings growth compared to the year before, but no decline either. The outcome conceals a varied result from operations with strong performance from the NanoTechnology Tools division offsetting a deterioration in OI Healthcare.

City analysts following the firm expect earnings to advance 14% for the year to March 2018 and 5% the following year. The expectation of growth is on the table and Oxford Instruments occupies a specialist niche in the market, which strikes me as a better basis for an investment than the conditions we see at Gattaca now.

I think it is a good idea to keep an eye on the firm’s debt levels. The company says it has reduced net debt but gives no figures. The last available balance sheet showed net debt running at almost six times the level of annual operating profit, which is on the high side, but the directors are focusing on bringing it down.

At a share price of 850p, the forward P/E ratio runs at just over 14 for the year to March 2019, which seems fair.