Shares in turnaround plays Mothercare (LSE: MTC) and HSS Hire Group (LSE: HSS) fell by about 6% this morning after both companies issued uncertain trading updates.
Mothercare and HSS have both lost about 50% of their market value over the last 18months. Is it time for investors to place bets on a recovery at each company, or do fundamental problems remain?
A tough challenge
Mothercare chief executive Mark Newton-Jones did his best to put a brave face on a poor set of interim results. He told investors that the second half has started in line with our plans and the business is well prepared for the important peak season.
According to todays report, 60% of UK stores have now been refurbished, and the majority of unprofitable stores have been closed. The groups internet presence has been upgraded and 40% of new business is now generated online, up from 36% last year.
Its certainly true that the second half of the year including Christmas is critical for Mothercare. About 65% of annual profit is made during this period.
Mothercares underlying earnings rose by 3% to 3.4p per share during the first half of the year. On this basis its possible that full-year forecasts of 10.1p per share remain realistic. These put the stock on a forecast P/E of 11. Expected earnings growth of 18% next year means that Mothercares P/E multiple falls to 9.4 for 2017/18.
Im sitting on the fence here. Although Mothercares sales do seem to be stabilising, the group is plunging back into debt as it upgrades its stores. The underlying loss at the UK business rose by 44% to 8.8m during the first half. My concern is that Mothercares decline has coincided with a weak period for the high street. Recovering from this could be tough. I believe there are better choices elsewhere in the retail sector.
This looks bad
Revenue rose by 10.9% to 256m at equipment firm HSS Hire Group, during the first nine months of this year. The company saidoperating profit before amortisation costs (EBITA) rose by 6% to 14.6m over the same period. This metric includes the effects of depreciation on HSS Hires rental equipment, so its a reasonable measure of cash profitability.
The groups profit margins also seem to be recovering. HSSs EBITA margin was 6% during the first nine months of last year. The equivalent figure for this year is 5.7%, but the company says that this has risen from 4.5% at the half-year mark.
Unfortunately, the firms turnaround plan is taking longer than expected. It will now extend into the first quarter of next year. Q4 trading is expected to be poor and management expects full-year EBITA to be below expectations.
Thats bad enough, but HSS Hires overwhelming problem is debt. The firms property and hire fleet were valued at 185m on 2 July, but the groups net debt is now 240m. HSS is effectively in negative equity.
Because debt always takes priority over equity, my view is that HSS shares are worth very little at the moment. I suspect the company will be forced to raise cash from shareholders at some point, in order to reduce debt. I certainly wont be investing in this turnaround story.
A real growth play?
If you’re looking for shares with the potential to deliver real, profitable growth, I’d steer clear of Mothercare and HSS Hire. The risks seem too high to me.
I’m much more interested in this retail company, which was chosen by our investment experts for A Top Growth Share From The Motley Fool. This profitable business is expanding fast. Our gurus believe the value of this company could triple over the next few years.
If you’d like to know more, download this free, no-obligation report today. To get started, just click here now.
Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
