Shares in Avon Rubber (LSE: AVON) have slumped by over 14% today after it released a rather disappointing update. Dairy market conditions have remained soft in the first quarter of the financial year, with general market conditions for dairy farmers (particularly in Europe) being weak as a result of low milk prices.
This has reduced demand for Avon Rubber’s consumable products as farmers extend the life through over-using product. Due to the capital nature of Avon Rubber’s InterPuls product, it makes the replacement cycle longer. Therefore, the outlook for Avon Rubber’s dairy division is rather uncertain, although the company continues to see an encouraging take-up of the innovative Cluster Exchange service across North America and Europe.
Meanwhile, Avon Rubber’s protection and defence division continues to offer a number of higher margin export opportunities. Although the timing of order receipts remains unpredictable, the long-term outlook for the unit is encouraging – especially with the integration of the Argus business having progressed well.
With Avon Rubber forecast to post a fall in its bottom line of 2% in the current financial year, investor sentiment could remain rather subdued in the coming months. That’s especially the case since its outlook remains relatively uncertain – as evidenced by today’s update. With the company’s shares trading on a price-to-earnings (P/E) ratio of 15.6, they could come under further pressure, so now doesn’t appear to be the right time to buy a slice of the business.
Challenges ahead
Also offering an uncertain future is Rolls-Royce (LSE: RR). It’s in the midst of a major turnaround after releasing multiple profit warnings in recent years. Realistically, it would be unsurprising if Rolls-Royce’s guidance was downgraded since trading conditions in a number of its important markets remain challenging. And with its shares continuing to command a premium compared to a number of sector peers, there’s scope for a reduction in Rolls-Royce’s P/E ratio, which currently stands at 18.2.
Rolls-Royce has a long road ahead of it as it seeks to recover lost ground from recent years. Clearly, it has a highly capable management team and a robust order book. But with the company’s bottom line due to decline by 43% in the current year, the scale of the task ahead is becoming clear. Such weak performance from a business with such an excellent track record of growth is highly unusual and indicates that, at a time when the aerospace and defence industries are facing an uncertain future, there may be better opportunities elsewhere.
That’s not to say that Rolls-Royce won’t deliver a successful turnaround, but rather that its current valuation doesn’t accurately reflect the challenges it faces. Furthermore, with a dividend cut to come in 2016 and potentially more in future, investor sentiment in Rolls-Royce could worsen in the coming months and lead to more share price declines following the 40% slump of the last year.
