This has thrown up some exciting opportunities, which may not be suitable for all investors. Indeed, the companies I’ve outlined are turnaround opportunities. Unfortunately, more often than not, turnarounds fail to turn around. 

Still, despite the risks involved, I’d buy the three UK shares outlined below for my portfolio today as recovery plays. 

UK shares to buy now

The first stock is the manufacturer and supplier of plastic and foam packaging products, Essentra (LSE: ESNT). Shares in this company crumbled at the beginning of 2020 after it reported a near-80% decline in earnings for 2019. 

It’s now trying to put this lousy performance behind it. For the six months ended 30 June, revenues increased 7.5% on a like-for-like basis. Adjusted profit jumped 34%, and adjusted basic earnings per share rose nearly 40%. 

These figures tell me Essentra’s heading in the right direction. Nonetheless, the company has its work cut out to restore investor confidence. It’s also built up a considerable level of debt during the past 24 months, which could hold back recovery. 

Despite these headwinds, I’d buy the stock for my portfolio as Essentra moves forward and builds on its recent growth. 

Property regeneration

Another company I’d buy for my portfolio of UK shares is U and I (LSE: UAI). It’s clear the UK’s facing a structural property shortage, and one way to alleviate this could be to convert old properties. This is U and I’s specialism.

The company partners with local authorities and long-term capital providers to help regenerate city centre locations. 

Recently, the company has undertaken a review of its operations. Management has set out goals to reduce costs and increase output as well as reducing debt. I think these changes will put the business on a solid footing to capitalise on the growing demand for real estate development in the UK. 

That said, there’s no guarantee U and I’s restructuring will lead to profits for the group. Property development can be time-consuming and costly if the project isn’t managed correctly. If projects overrun significantly, the developer may encounter financial problems. 

However, I’d buy this company for my portfolio of UK shares, considering its recovery potential. 

Financial services

The final stock I’d acquire for a recovery portfolio is Metro Bank (LSE: MTRO). This company’s quite risky. In recent years, it’s struggled to earn a profit. And regulators have reprimanded it for failing to account for risk on its balance sheet correctly.

These challenges have really hurt its reputation among investors. However, from a customer point of view, Metro offers something most banks don’t. Its branch network and focus on customers over profit really stand out.

In a world where its competitors are slashing costs and removing branches from town centres, I think Metro has the edge. As such, I think if the business can get past the challenges outlined above, I think it could make a solid recovery play in my portfolio of UK shares. 

Instead, I’d buy shares for my Stocks & Shares ISA because the dividends they pay can be reinvested and compounded in a similar way to how interest builds up in an ISA cash savings account.

Growing from an inflection point

I like the look of FTSE 250 manufacturing company Essentra (LSE: ESNT), which has a dividend yield running close to 5%. The share price has dropped by around 60% since its peak around four years ago but has been clawing its way back up through most of 2019, so far. But the weakness in the price is part of the reason for the high dividend yield, so I see it as an opportunity for investors.

There have been operational problems causing profits to dip. But in today’s half-year results report, chief executive Paul Forman said that in 2018, Essentra reached an “inflection point” and the firm is now set for sustainable growth in revenue and profits. On that theme, I find today’s figures to be encouraging.

Like-for-like revenue for the first half of the year to 30 June moved 1.3% higher than the equivalent period last year, and adjusted basic earnings per share at constant currency rates lifted by 7.5%. The directors maintained the interim dividend, which is reassuring given all the ongoing changes in the business.

Streamlining for growth

Indeed, the firm has been busy nipping and tucking operations, involving selling off underperforming divisions and acquiring new bolt-on businesses. But Essentra is no stranger to building growth via the acquisition route and has a long history of taking over other firms and businesses. From its roots as a manufacturer of filters for cigarettes, which it still produces, Essentra now claims to be a “leading global” provider of “essential” components and solutions with the three global divisions of Components, Packaging and Filters.

Today the firm reported “positive” momentum maintained in its Packaging division, which “returned to growth” in the last half of 2018. Paul Foreman explained in today’s report that the firm is in the process of “simplifying” operations. So far this year the subdivisions of Pipe protection, Extrusion, Speciality Tapes and Card Solutions have all been sold off. The Kilmarnock and Largo consumer packaging sites were also closed down at the end of last year. And on top of that, Essentra made a couple of acquisitions in the first six months of 2019.

I reckon simplification and increased focus is almost always a good thing in business, which makes me optimistic about the firm’s future prospects and its potential to recover and grow. At the recent share price of 408p, we can pick up a few of the shares on a forward-looking earnings multiple of just over 15 for 2020, which I’m inclined to do. Meanwhile, the anticipated dividend yield is around 5%, which looks attractive to me.

My aim is to find stocks that are about to come back into favour with investors, triggering a major re-rating. Today I’m looking at two possible examples.

On the cusp of a turnaround?

My first stock is specialist manufacturer Essentra (LSE: ESNT). This FTSE 250 firm makes a range of products. These include cigarette filters, specialist packaging for the health and consumer sectors and plastic components for a wide range of applications.

Cigarette filters generated £34.8m of operating profit last year — about 40% of the group’s total operating profit. Most of the remaining profit came from the components division, which generated £58.7m from a wide range of industrial customers.

Essentra has lost more than 45% of its value since 2015, when the stock peaked at over 1,000p. But the board’s restructuring programme is now largely complete. Management guidance for the year ahead is for “a return to like-for-like revenue growth and margin expansion” in 2018.

I’m tempted by this 4.9% yield

Broker forecasts for 2018 suggest that the group’s adjusted earnings will rise by 11% to 24.5p per share, with a dividend of 20.8p per share. These figures put the stock on a forecast P/E of 17.5 with a prospective yield of 4.9%.

Although earnings cover for this dividend is slim, I don’t expect the payout to be cut now that profits are rising again. With profits expected to climb a further 15% in 2019, I’d rate Essentra as a buy at current levels.

This 7% yield may be worth buying

Although the long-term decline in cigarette smoking is old news, investors are starting to get concerned that next-generation vaping products may not be able to replace these lost sales.

UK number two Imperial Brands (LSE: IMB) has seen its share price fall by more than 30% over the last year. This stock now offers a forecast yield of 7.4%, but even that hasn’t been enough to tempt dividend investors back into the shares.

It’s certainly true that high yields such as this are often a sign that a dividend cut is likely. But sometimes the market just gets it wrong for a while.

I’m turning bullish

Imperial Brands’ key attraction for investors is its free cash flow. Historically this measure of surplus cash has broadly matched the group’s earnings, providing support for a very high level of dividend payouts.

Measured in this way, the group’s forecast dividend of 187p per share looks to me like it should be affordable. The only potential problem is the high level of debt.

Because management have focused on returning free cash flow to shareholders, most of the acquisitions made in recent years have been funded with borrowed cash. This left the group with net debt of £12.1bn at the end of September 2017. That’s nearly five times forecast profits for this year, which seems a little high to me.

Net debt fell by £800m last year. If this total continues to fall this year, then I suspect the dividend will be safe. We’ll find out more when the group publishes its half-year results on 9 May. Until then, I’m going to give the stock a cautious buy rating.

But Friday’s release has given Essentra’s stock value a welcome shot in the arm, the stock last dealing 6% higher on the day.

The FTSE 250 business advised that pre-tax losses had narrowed to £5m in 2017 from £63m in the prior period.

Revenues rose 3% to £1.03bn, although this was thanks to favourable foreign currency movements — on a like-for-like basis they actually slipped 2% from 2016 levels. Having said that, the impact of hurricane activity in the US and Puerto Rico took a bite out of the top line in the period.

Commenting on the results, chief executive Paul Forman said: “I have previously expressed that restoring Essentra to sustainable, profitable growth is not a rapid journey, and we clearly have a lot of work still to do. However, together we have made great progress and tangible improvement in 2017, so we are already well on our way.”

Back to growth

With Essentra predicted to move back into a period of earnings expansion now — rises of 19% and 14% are forecast for 2018 and 2019 — brokers are also expecting the firm to start lifting dividends again too.

So after paying a 20.7p per share reward for each of the past three years, Essentra is anticipated to lift the dividend to 20.8p this year and again to 20.9p next year. Consequently investors can tap into tasty yields of 4.4% and 4.5% respectively.

That being said, cautious share pickers should recognise that these projections aren’t very well covered. Predicted dividends are covered just 1.3 to 1.4 times by predicted earnings through to the close of fiscal 2019, well below the widely-accepted security benchmark of 2 times and above.

Now Essentra is expecting to make further headway in 2018 and to finally report a return to like-for-like sales growth this year. Its progress is to be lauded, although it still has some way to go, and I therefore do not believe risk-averse investors should splash out on the stock today, particularly given its slightly-toppy forward P/E ratio of 17.9 times.

Bumper yields well protected

Indeed, I would be much happier to take my investment cash and to spend it on National Express Group (LSE: NEX) instead, and not just because of its far superior valuations.

The 8% earnings improvement predicted for 2018 leaves the bus operator dealing on a forward P/E multiple of just 11.5 times. An extra 4% profits rise is predicted for next year, and these bright projections lead to expectations of handsome dividend expansion.

The 13.51p per share reward of last year is anticipated to rise to 14.8p this year, and again to 15.8p in the following period. These figures yield a chunky 4.1% and 4.4% respectively.

To put the cherry on the cake, dividend coverage through to the end of 2019 stands at an impressive 2.1 times.

I am impressed by the splendid progress National Express continues to make in foreign climes, and with the company steadily expanding its international footprint I am convinced that both earnings and dividends should continue their trek higher.

However, despite these two companies’ lacklustre capital performances I believe that, as income stocks, Essentra and Halfords should not be ignored. Here’s why. 

Growing dividend potential 

Today, Essentra announced that it had seen modest revenue growth in the third quarter after all divisions saw an improvement. This performance is impressive considering that the business has been subject to disruption by the hurricanes that have hit the US this year.

The division suffering from these storms the most is its Health & Personal Care Packaging division. Here, the division saw an “improved” revenue decline in the quarter, “notwithstanding the impact of Hurricane Maria on the two sites in Puerto Rico.“

Still, the overall trend is positive, and this was the first such period of like-for-like revenue growth since fourth quarter 2015, according to management. 

Essentra’s biggest strength is its cash generation. Even though growth has vanished over the past few years, cash flows have remained robust. During the past five years, the firm generated £341m in free cash flow from operations, excluding dividends. Of this total, £195m was distributed to investors. 

These figures indicate to me that, over the next few years, there’s scope for Essentra to double its dividend payout. Last year, the company generated £153m in cash from operations, spent £47m on CapEx, and returned £54m to shareholders. A similar performance this year leaves room to payout an extra £52m for a total of £56m. If growth returns in the years ahead, cash generation will undoubtedly improve – giving management more headroom for payout growth. 

At the time of writing the shares support a dividend yield of 3.9%. 

Unloved by the market 

Halfords currently supports a dividend yield of 5.5%, which indicates to me that the market doesn’t think much of the company. Nonetheless, the group has plenty of room to grow its dividend payout in the years ahead. 

Indeed right now, the payout is covered 1.7 times by earnings per share and analysts are already projecting a 3% payout hike next year. Looking at the group’s cash flows, it appears there’s scope of an even more significant distribution. 

2015 was the company’s most profitable year in the past five. For that year, the firm produced a pre-tax profit of £84m and a free cash flow of £120m. Dividends paid for the year cost £28m. If management can get the company back to this position, there’s plenty of headroom for additional payout increases. Even doubling the distribution, in this case, would be viable. With a gearing ratio of only 25% as well, Halfords’ balance sheet is strong enough to support higher distributions on an annual basis, or even a special payout. 

The shares are currently trading at an attractive valuation of 11.2 times forward earnings. 

However, with the risks of Brexit causing the pound to weaken, and a monetary policy that is due to remain relatively loose, an even higher yield may be required to generate a worthwhile real income return. That’s where a company such as BP (LSE: BP) may prove useful for long-term income investors, with its 6.3% yield offering a 3.4% return above inflation at the present time.

A bright future

Clearly, BP lacks the diversity which the FTSE 100 offers. The index, by its very nature, includes a wide range of companies operating in a variety of sectors. Therefore, the chances of a sharp fall in dividends is reduced versus investing in a single stock such as BP. As such, for investors who are looking for a safer income stream over the long run, the index could be a good place to start.

However, BP could be a surprisingly strong performer in future years. The company has experienced a difficult period, with the oil spill in 2010 and oil price fall of the last few years placing its business under intense scrutiny and pressure. This has led to management changes and has also meant that the company’s asset base is perhaps smaller than it otherwise would have been had investment been higher.

Despite this, the company is expected to post impressive levels of profitability over the next couple of years. For example, its bottom line is due to rise by 33% in 2018 after it returns to profit in the current year. This puts it on a price-to-earnings growth (PEG) ratio of just 0.5, which suggests that it offers excellent value for money at the present time.

Even though dividends are not due to be fully covered by profit next year, further improvement in its financial position could be ahead as the financial cost of the oil spill comes to a close. This could make BP a sustainable and highly appealing income stock for the long run.

More income potential

Also offering strong income prospects for the long term is plastic, fibre, foam and packaging products supplier Essentra (LSE: ESNT). On Monday it released an assessment of the recent Hurricane activity in the Americas, with two of its Health & Personal Packaging sites in Puerto Rico having been disrupted. While the facilities have not sustained physical damage, they have not been operational since 19 September.

The company is understandably focused on ensuring the safety and wellbeing of its employees. However, it expects the financial impact from the two facilities not being operational to be between £500k and £750k per week, although a significant proportion of that is due to be recovered through insurance policies.

While there is no certainty as to when the company’s two sites will be operational, Essentra continues to offer a favourable income outlook. It has a dividend yield of 4.2% from a payout which is covered 1.2 times by profit. With the company trading on a PEG ratio of 1.1, it also appears to offer significant upside potential.

Client list

Equiniti posted mundane revenue growth of just 1.5%, along with a 0.6% decline in organic growth, pleading interest rate headwinds and second-half bias. The good news came in the form of 100% client retention across all divisions, with new wins including Aon Hewitt, British Bankers’ Association and House of Fraser, and fresh mandates from Alpha FX, Arix Bioscience, Global Ports, Ramsdens and Xafinity.

DS Smith, Imperial Brands, Lloyds Banking Group and Santander either renewed or extended, making up a strong client list. Equiniti also boasts strong cash flow conversion of 109%, free cash flow growth of 9.2% to £20.2m, underlying earnings per share growth of 6.2% to 6.9p and interim dividend growth of 6.7% to 1.75p, in line with the progressive dividend policy.

Moving on up

The £800m company’s recent acquisition of Wells Fargo Share Registration & Services has been warmly received, as it should turn the company into an international play, rather than a domestic one. The outlook remains bright despite today’s disappointment, even if recent share price growth has driven the valuation to 16.8 times earnings, on a yield of 1.9%. EPS growth is forecast to be just 2% this year, but that is set to hit 11% in 2018. Today’s share price dip could be a good time to jump on board.

Packaging and filter products producer Essentra (LSE: ESNT) is in the early stages of a major and much-needed turnaround, after delivering its third profit warning in a year in January. The £1.41bn company, which makes cigarette filters and plastic packaging, warned that profits should miss expectations due to operational issues at its health and personal care packaging unit. Today’s half-year results to 30 June cover what it calls a period of stabilisation and strategic development.

The Essentra-ials

Essentra still has a long way to go. Today it reported a 4% drop in like-for-like revenues, with adjusted operating profit down 35% at constant exchange rates to £43m, and basic adjusted earnings per share down 38% to 11.2p.

There was some good news. Net debt is now £207m, down from £379m on 31 December 2016, aided by the divestment of its Porous Technologies division. Operating cash conversion has improved from 59% to 70% year-on-year, reflecting greater underlying stability in the business. The half-year dividend remains unchanged at 6.3p per share. The stock  yields 3.8%.

Fighting back

Paul Forman, appointed CEO seven months ago, says Essentra has stabilised after a period of turbulence, and is starting to win back lost credibility with his customers, but there is clearly much to do. Packaging can be a lucrative industry – Mondi and Smurfit Kappa have got it wrapped – and recent problems have been caused internal rather than external issues.

Essentra is turning into a paper tiger with its share price up more than 30% in the last six months, although trading at 18.34 times earnings it needs to show more teeth.

Dividend growth

Reporting on Thursday was specialist components manufacturer and distributor Essentra (LSE: ESNT). Its trading update showed its performance since the start of the financial year has been in line with expectations. Like-for-like (LFL) revenue has modestly declined, as expected, although the trend in all three of the company’s divisions has been better than in the same period a year ago.

The actions taken in its Component Solutions and Filter Products divisions have put the two key segments on a more stable financial footing for the future. Now the company will focus on its Health & Personal Care Packaging sector, which has reported a significant decline in sales and profitability in recent months.

However, the difficulties faced by the business have not led to dividend cuts. Essentra currently yields around 3.9% from a dividend which is covered 1.3 times by profit. This shows its current level of payout is sustainable. And with profit due to grow by 15% next year, there is scope for a rise in shareholder payouts over the medium term. This could boost its share price performance and lead to capital gains – especially with Essentra trading on a price-to-earnings growth (PEG) ratio of just 1.5.

Cheap dividend potential

Also offering upbeat income prospects is UPVC windows manufacturer and distributor Eurocell (LSE: ECEL). It has performed relatively well in the last couple of years and has been able to grow earnings by over 50%. This growth trend is forecast to continue in the current year and next year, with earnings growth set to average around 9% per annum during the periods. This should allow dividend growth of almost 10% per annum over the course of 2017 and 2018.

Despite such a rapid growth in dividends, Eurocell looks set to offer a highly sustainable level of shareholder payouts. Its dividends are currently covered 2.4 times by profit, which indicates they could increase at a much faster pace than profit without hurting overall financial strength. And since its shares trade on a PEG ratio of just 1.4, there seems to be significant upside potential on offer, too.

Clearly, an uncertain economic outlook could mean there is scope for downgrades to its financial performance. However, with a generous yield of 3.5% and a relatively low valuation, the market may have already priced a degree of volatility into the company’s share price.

Plastic fantastic

Shares in Essentra (LSE: ESNT) soared by 33% in February, for the biggest gain in the FTSE 250 — and at 535p as I write, they’ve put on another couple of pennies since the start of March.

Essentra isn’t a flash new growth star that’s excited the punters, it’s a supplier of specialist plastic, fibre, foam and packaging products that’s turning itself around from a poor 2016. The firm reported a 9% fall in like-for-like revenue, with adjusted EPS falling by 31% to 36.3p and net debt rising slightly to £379m.

But the dividend was maintained, which cheered those shareholders who had been fearing a cut. The disposal of the firm’s Porous Technologies business should complete in the current quarter to significantly reduce debt, and Essentra told us its turnaround plan is “already initiated, focusing on re-establishing stability and accountability“.

There’s a new chief executive, Paul Forman, at the helm now, and I like to see that in a company needing serious remedial work — a new boss can potentially sweep cleaner than an incumbent without being blamed for the past. In fact, Mr Forman described Essentra’s 2016 problems as being “predominantly self-inflicted, and therefore capable of reversal“.

The recovery won’t be immediate, and Mr Forman anticipates a further fall in revenue and operating profit in 2017. But analysts already have a 14% EPS recovery pencilled-in for 2018, putting the shares on a forward P/E of just under 18.

With those retained dividends (yielding around 4%) lending support and debt set to fall, I think February’s gains could presage a strong recovery for Essentra over the next few years.

Hot metal

Results for 2016 gave Bodycote (LSE: BOY) a boost on 28 February, helping send the shares up 19% over the month — and with a small extra gain since, they’re up 38% in three months to 817p.

Results from the metallurgical services specialist showed headline pre-tax profit (excluding exceptionals) falling by 2.2% to £97m, with headline EPS dropping 6.3% to 37p, and net cash plunging from £12.3m to just £1.1m. So why was the market so enthused?

For one thing, the dividend was lifted by 4.6% to 15.8p — that’s only a yield of around 2%, but it’s more than adequately covered at around 2.3 times, and it lends support to analysts who are forecasting further rises this year and next.

Another factor that seems to be playing its part is the cyclical nature of the engineering sector in which Bodycote provides its services. A strong ‘Buy’ consensus for Bodycote from analysts, combined with improving sentiment towards our major aerospace and defence companies, suggests we’re getting past the bottom of the cycle and could be in for a new bull phase.

Chief executive Stephen Harris said: “While our business, by its nature, has limited forward visibility, we continue to demonstrate that we are capable of adapting with great agility to changes in market conditions,” adding that he believes the company will “will generate good returns through the cycle“.

I confess I’m a little nervous about Bodycote’s forward P/E going into 2017 of over 20 with dividends only expected to yield around 2.5%. But if the turnaround is here and Bodycote’s agility is as great as Mr Harris suggests, the shares could be good value.

A recovery play

The oil sector has been a difficult place to invest in recent years. Profitability has come under pressure due to lower prices for black gold, but following the decision by OPEC to cut production the industry may have turned a corner.

Certainly, the outlook for oil & gas support services company Amec Foster Wheeler (LSE: AMFW) has improved. Although it is expected to record a fall in profitability in 2017, its bottom line is due to rise for the first time in four years in 2018. This could help to improve investor sentiment in the stock, and also push its dividends higher. It may only be growth of 8% in earnings, but it means that Amec Foster Wheeler’s dividends are set to be covered 2.3 times by profit. This means they could rise rapidly and push its dividend yield of 4.9% higher over the medium term.

Alongside its income appeal, Amec Foster Wheeler also offers capital growth potential. Its shares trade on a price-to-earnings (P/E) ratio of just 8.6. Given its prospect of a rising bottom line, a higher rating may be justified over the medium term. This could make its total return exceed that of the wider index not just in 2017, but in future years, too.

Solid income stock

Manufacturer of component parts Essentra (LSE: ESNT) offers a relatively stable and consistent outlook for dividend investors. This could be well-suited to the outlook for the economy, since uncertainty is relatively high. As such, the company’s shares could become increasingly in-demand as investors seek relatively secure income streams.

Essentra currently yields 4% from a dividend which is covered around 1.5 times by profit. This indicates that there is adequate headroom to raise dividends at a similar pace to profit growth over the medium term. With earnings growth of 11% forecast for next year, Essentra’s shareholder payouts could grow at a rate which is well in excess of inflation.

Additionally, it trades at a slight discount to its historic average P/E ratio. Its rating is currently 18.1 versus an average over the last five years of 18.6. Therefore, there is some upward rerating potential, which when combined with its earnings growth prospects means Essentra could prove to be a top notch stock to hold for the long run. In fact, its price-to-earnings growth (PEG) ratio of 1.6 indicates that it offers growth potential at a reasonable price, thereby further enhancing its investment case.