Today I’m looking at two stocks which I believe have the potential to deliver stunning comebacks. Both companies have been out of favour, but are starting to attract investor interest as trading improves.
Printing profits
Commercial inkjet printing specialist Xaar (LSE: XAR) made its name with digital technology for printing designs on ceramic tiles. But this former growth business has now matured and the group is trying to diversify into areas such as 3D printing.
Today’s half-year results have pushed the shares up by 3%, suggesting to me that investors are cautiously optimistic about the firm’s progress. Product revenue excluding ceramics rose by 60%, confirming that the group’s diversification strategy is working.
However, revenue from the group’s ceramics business fell by 25%, offsetting much of the growth elsewhere. The company says that almost all production capacity has already been converted to digital technology of the kind provided by Xaar. So future sales will be largely limited to product replacement.
Overall revenue for the period was broadly unchanged from the first half of last year, at £44m. Adjusted pre-tax profit fell from £8.8m to £7.9m, while net cash dropped from £49.3m at the end of 2016 to £38.3m at the end of June.
The group expects to report “continued new product growth” during the second half of the year. Current forecasts put the stock on a forecast P/E of 28 for 2017, with a prospective yield of 2.9%.
This looks expensive, but broker forecasts also suggest that profits may rise by 38% in 2018, as sales take off. If these projections are correct, Xaar could enjoy several years of strong momentum, justifying a higher share price.
On balance, I’d give this stock a cautious ‘buy’ rating.
This year’s biggest surprise?
When Sports Direct International bought a 26% stake in video games retailer Game Digital (LSE: GMD) in July, it kick-started a surge of demand for the firm’s shares. Further gains were seen after a strong trading update in August, and the shares are now worth 40% more than they were one month ago.
The group expects to report net cash of £47m for the year-ending 30 July. Based on the current market cap of £63m, this means the market is valuing Game’s retail business at just £16m.
One reason for this is probably that this business is only marginally profitable. Although sales are expected to have risen to £780m last year, analysts are forecasting a net profit for the year of just £6.1m. I’d normally be cautious about getting involved in a situation like this, but I believe the company has some advantages.
The first is that the store portfolio is all on very short leases. Management should be able to take advantage of falling high street rents to cut costs.
Game is also making good progress in the fast-growing ‘e-sports’ live gaming market. Revenue from events and e-sports rose from £4.8m to £7.1m last year, and the group is prioritising further development of this area.
Finally, in 2014 and 2015, the company generated an operation margin of about 3%. If management can return performance to this level, then I believe the shares would look very cheap indeed at under 40p. I continue to rate the shares as a special situation ‘buy’.