Spotting deep value stocks can be a profitable way to invest. These shares can sometimes provide rapid and spectacular gains. But true bargains are fairly rare. Cheap stocks are often cheap for a good reason.
In this piece I’m going to look at the investment case for two potential value buys.
Will boardroom clearout lift shares?
Gold production at Russia-focused miner Petropavlovsk (LSE: POG) rose by 19% to 232,400 ounces during the first half of 2017. According to the group’s half-year trading update, full-year production guidance remains unchanged at 420,000 to 460,000 ounces.
The group’s share price has also remained unchanged following today’s update. But the company’s boardroom has seen big changes recently. Founder Peter Hambro has been ousted from the chairman’s position and demoted to non-executive director.
And his longstanding business partner Pavel Maslovskiy announced on Monday that he has resigned from his role as chief executive.
Petropavlovsk survived a debt-fuelled crisis in 2014/15 by persuading shareholders to back a major refinancing deal. But some shareholders have been disappointed by the firm’s decision to fund expansion projects rather than focusing on debt reduction.
Management said today that net debt has fallen by 5% to $570m (£438m) over the last six months. That’s still very high, in my view, given that the group’s market cap is just £231m, and 2017 net profit is expected to be just £35.7m.
The shares currently trade on a forecast P/E of about 3.5, and at a 50% discount to their book value of about 12p per share. I believe there should be an opportunity here, but I’m concerned by management’s focus on expansion and the slow pace of debt reduction. In my view, there are better buys elsewhere in the gold mining sector.
The right time to buy?
Gulf Marine Services (LSE: GMS) has a new and modern fleet of jack-up rigs of the kind used by the offshore oil and gas sector. The problem is that rental demand is fairly weak at the moment. This could make it difficult for the firm to service and repay its net debt of $370m.
To put these borrowings in context, $370m is more than two years’ revenue at current levels, and eight times 2018 forecast profits of £44m.
At the current price of 55p, Gulf Marine stock trades at a 44% discount to the firm’s book value of 98p per share. That discount represents a potential opportunity, as the firm’s fleet build-out programme is now complete. Spending should fall sharply, providing surplus cash to reduce debt levels.
Analysts also expect the firm’s profits to rise significantly over the next year. The group is expected to report adjusted earnings of 6.8 cents per share for 2017, rising by 83% to 12 cents per share in 2018. This puts the stock on a 2017 forecast P/E of 10.8, falling to a P/E of 5.9 for 2018.
If oil market conditions become more favourable in 2018 — as I suspect they might — then Gulf Marine Services could be a profitable buy at current levels. But I’d only want to hold this share as part of a diversified portfolio. In my view, the level of debt involved mean that this stock is still quite risky for equity investors.