The line between value play and value trap is never an easy one to walk. Investors whove been in the market for years will inevitably have their tale of the time they made or lost a fortune betting on a beaten-down shares recovery. After a year of shedding more than a fifth of their market cap each, are BHP Billiton (LSE: BLT), Tesco (LSE: TSCO) and Sports Direct (LSE: SPD) more value play or value trap?
Multi-billion pound losses and slashed dividends have been the story for mining companies over the past 18 months. BHP Billiton finally joined the party this month by announcing a 75% dividend cut, the end of progressive payouts, and a staggering $5.7bn loss for the past half year. On the bright side, strong cash flow from low-cost assets mean net debt has increased a mere 4% over the past year to $26bn.
Income investors will decry the lower dividend, but it will allow BHP to maintain its A credit rating during what management predicts to be a prolonged period of weaker commodities prices. Despite prices for the majority of BHPs major commodities dropping in price by double-digits in just the past six months, underlying profits of $6bn were still recorded.
With low-cost assets still contributing to cash flow and net gearing a reasonable 30%, I believe BHP will be in a great position once commodities prices inevitably rise. For long-term investors, I believe BHP could be an astute purchase at todays prices.
A basket of issues
After years of strong growth, shares of retailer Sports Direct have stumbled lately as revenue growth has slowed at the discount retailer. While the company remains solidly profitable, it warned in January that it wouldnt meet internal guidance for full year 2016 profits. Analysts are forecasting a return to earnings growth for 2017, and shares are currently trading at a very low 10 times these earnings.
While this valuation may make the shares appear a bargain to many, I remain unconvinced. The companys corporate governance raises significant red flags, stretching from the well-noted staffing issues to a lack of transparency and possible issues with related-party transactions.
These problems alongside slowing growth at home and a rocky rollout of international expansion would lead me to steer clear of shares.
The margin question
The well-known accounting scandal and massive debt levels at grocery giant Tesco have understandably cut share prices significantly over the past few years. However, what worries me more for the long term is the dramatic fall in margins at the company. While it once boasted operating margins in the mid 5% range, this number has shrunk to 1.3% for the company as a whole and under 1% in the UK.
Competition in the sector from discounters and online-only outfits is unlikely to let up any time soon. This will leave Tesco stuck between a rock and a hard place, either going upmarket to compete with J Sainsbury and Waitrose, or trying to fight with the discounters. Either option leaves it with lower margins than it traditionally enjoyed.
While there are signs that the company is finally stabilising falling profits, I dont see a catalyst on the horizon for Tesco shares turning around and becoming a big long-term winner.
Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Sports Direct International. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.