Pockets of value can often be found in unlikely places in the stock market. Today I’m going to look at two companies whose sectors are out of favour, but which seem to be trading well. Both stocks look fairly cheap to me. Should value investors take a closer look?
Baked-in profits
Like-for-like sales edged 0.3% higher to £314.3m last year at cake and bakery foodservice company Finsbury Food Group (LSE: FIF). The firm confirmed this morning that profits for the year ended 2 July are expected to be in line with market expectations, despite fairly tough trading conditions.
This AIM-listed group has a market cap of just £151m, but is a fairly high-quality business in my view. The group’s return on capital employed — a useful measure of profitability — rose from a historical average of about 10% to 14.5% in 2016. Operating margin edged above 5%, a respectable achievement for a business of this kind.
A further attraction is that unlike some sector rivals, Finsbury appears to have a fairly strong balance sheet. Net debt was £21m at the end of December. That’s equivalent to a net debt-to-EBITDA ratio of just 0.8, well below the two times threshold that’s generally considered to be a risk level.
So what could go wrong? The biggest risk for a business of this kind is that profit margins will be continually squeezed. Customers tend to demand lower prices, while raw ingredient and wage inflation can push up costs. One current problem mentioned by management in today’s update is the price of butter, which has doubled over the last year.
However, the group says it is having “productive discussions” with customers regarding the recovery of these extra costs. Finsbury shares edged lower after today’s news. But with the stock trading on a forecast P/E of 11 and offering a well-covered forecast dividend yield of 2.6%, I think this baker could be worth considering.
A star player
Many of the biggest names in the retail sector are struggling in the face of internet competition. One surprising exception to this is electronics group Dixons Carphone (LSE: DC).
Although you might expect the firm’s profits to be under pressure from low-cost online sellers, this doesn’t seem to be a big problem. The group’s latest results revealed that like-for-like sales rose by 4% last year, while adjusted pre-tax profit rose by 10% to £501m.
However, this apparently strong performance was flattered by £28m of one-off gains relating to lower-than-expected costs on long-term customer support contracts. In reality, I think it’s probably fair to say that underlying pre-tax profit rose by about 4% — in line with sales growth.
Although this may not seem so impressive, I think it’s a pretty solid performance in the current environment. The group’s 4% operating margin isn’t anything to be ashamed about either, and debt levels remain very low.
The market doesn’t seem to agree with my positive view on this firm. Dixons’ share price has fallen by 14% since its results were published on 28 June. That’s left the stock trading on a 2017/18 forecast P/E of just 7.7, with a potential dividend yield of 4.4%.
In my view, this downbeat valuation could be a buying opportunity for contrarian investors.
