The FTSE 250 has been a great source of ideas for successful investments in recent years. But not all of its stocks have turned out to be top performers.
Today I’m looking at two companies that have lagged the mid-cap index over the last five years. Both firms have recently released news suggesting that they could now be profitable turnaround buys. But risks remain. So is now the right time to buy?
Dialling up growth
Phone and broadband group TalkTalk Telecom Group (LSE: TALK) has lost 54% of its value over the last five years. But the company’s fortunes are looking up. The TalkTalk share price rose by up to 8% on Tuesday morning after the company reported a 4% increase in core revenue during its first quarter.
The group added 80,000 new customers during the period and said that 2.1m of its 4.2m customers were now signed up to fixed low-price plans. This is helping to keep customer churn low, with just 1.28% of customers leaving during the period.
Debt worries
The group’s turnaround appears to be going well. My only remaining concern is the level of debt. Net borrowing totalled £755m at the end of March. This gave a net debt/EBITDA ratio of 3 times — well above my preferred maximum of 2 times.
Plans to reduce debt levels by selling the firm’s business division to Daisy Group have fallen through. But the company needs to keep spending in order to upgrade its network. My feeling is that further debt reduction could be slow, unless the company resorts to another equity placing.
The right time to buy?
Although I’m concerned about TalkTalk’s debt levels, the company confirmed today that adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) are expected to rise by 15% this year, in line with previous guidance. If net debt remains flat, this earnings growth should reduce the group’s net debt/EBITDA ratio to a more acceptable 2.6 times.
Analysts expect adjusted earnings of 5.9p per share this year, rising by 30% to 7.7p per share in 2019/20. These figures put the stock on a forecast P/E of 20, falling to a P/E of 15 next year. Now could be a good time to take a fresh look at this turnaround story.
This could be a value trap
When management turns down a takeover proposal for a troubled business, it has to be confident it can deliver a superior result for shareholders. The jury is still out on whether bus and train operator FirstGroup (LSE: FGP) will be able to do this after recently rejecting a takeover proposal from private equity group Apollo Global Management.
The firm faces a number of headwinds. At £1,070m, net debt is still too high, despite falling last year. Improved cash flow should help this figure to reduce, but the Aberdeen firm also faces issues in its Greyhound and TransPennine Express operations.
A trading update today confirmed that performance so far this year is in line with expectations. FirstGroup has begun to withdraw from some of its Greyhound operations in Canada, which is expected to improve profit margins from road operations.
The shares look cheap on 6.7 times forecast earnings, with a forecast yield of 4%. But this company has disappointed investors for a number of years. Although it may now deliver a successful turnaround, I believe there are better buys elsewhere in the transport sector.