Today I’m looking at two controversial and rather battered FTSE 100 stocks. I believe the outlook for each company may not be what you might expect, given recent news.
The first share under consideration is £32bn pharma group Shire (LSE: SHP). Chief executive Flemming Ornskov has never been short of ambition for his firm, and last year he went all out with a $32bn deal to acquire US firm Baxalta.
The benefits of this deal are now starting to appear. In its third-quarter results on Friday, the group reported a 20% increase in adjusted earnings, which rose to $3.81. This corresponded to a 20% increase in adjusted net profit, which rose to $1,158m.
Highlights from the quarter included a 32% increase in sales of immunology medicines, compared to the same period last year. This helped to offset the effects of weaker demand for genetic treatments.
Improving financials
The group’s financial performance has certainly improved this year. Net cash generated by operating activities doubled to $1,055m during the quarter, helping Shire to reduce its net debt by a further $920m.
With nine months of the year complete, management has left its guidance for the full year unchanged. Based on broker forecasts, this suggests that the stock trades on a forecast P/E of 9.3 for 2017.
This may seem cheap, but it’s worth remembering that the group’s net debt of $20.4bn makes the stock significantly more expensive than the P/E ratio suggests.
An alternative valuation measure I like to use is earnings yield, which compares operating profit with enterprise value (market cap plus net debt). I estimate Shire’s earnings yield at about 3.5%, but I normally prefer to invest in stocks with an earnings yield of at least 8%.
In my view, it’s probably too soon to check back into Shire.
Shopping for a bargain?
High street stalwart Marks and Spencer Group (LSE: MKS) is seriously out of fashion at the moment. But the group’s food business is growing steadily, and selling clothes still generates a lot of cash.
Indeed, the group’s shares currently trade on a trailing price/free cash flow ratio of just 8.6, which is very cheap if it’s sustainable. The evidence so far is that this cash generation can be sustained.
Indeed, the firm’s adjusted earnings are expected to bottom out at 27.9p per share this year, before climbing to 28.5p in 2018/19. This puts the stock on a reasonable forecast P/E of 12.4. It also provides a decent level of cover for the expected dividend payout of 18.7p per share, which implies a yield of 5.4% at the share price of 345p.
I’m starting to be get interested in M&S, as I think the group’s Food business should continue to offset a slower recovery in the clothing and home divisions. The first-quarter figures published in the summer seem to support this view — Clothing & Home revenue fell by 0.5%, but Food sales rose by 4.5%.
The business is being reshaped to provide more space for Simply Food, and to improve the stores’ integration with the group’s online sales channels. This seems logical to me and although it’s too soon to be certain, I believe now might be a good time to buy into the turnaround.