Buying potential recovery stocks is an inherently risky business. After all, for them to be classed as possible recovery plays means that their financial performance has been disappointing in the recent past. There is no guarantee that this will improve, and in the meantime investor sentiment can decline dramatically to leave investors nursing major losses.
However, recovery shares also offer significant upside potential. They often include a wide margin of safety and, with the right strategy and trading conditions, can deliver strong capital growth for investors.
A disappointing update
Reporting on Friday was global programme, project management and technical consultancy business WYG (LSE: WYG.L). Its share price declined by 40% after it released a profit warning. While it expects revenue for the full year to exceed £160m as previously forecast, it has revised its expectation of near-term operating performance. It now anticipates that operating profit will be significantly lower for the half year than in the same period of the prior year.
One reason for the company’s profit warning is the fact that two recent contract wins have taken longer to start than anticipated. In Turkey, for example, WYG expects a lull in activity around the end of the calendar year and this is due to impact on the timescales for new work. Furthermore, after a review of major contracts within its Consultancy Services business it has concluded that a small number of engineering contracts are likely to deliver lower profitability than previously forecast.
In addition, the company’s Planning and Transport Planning practices have performed below expectations in the early part of the year. It expects operating profit from this core area of activity to be significantly below budget. And with the real estate business which was acquired in October 2015 performing below budget, it is no longer expected to meet its profit target.
Looking ahead
While WYG’s update was hugely disappointing, the company seems to have a sound platform from which to grow. Its order book is strong, while its new management team appears to be confident in the company’s outlook following the review.
One company which has been able to deliver a successful turnaround is banking stock Standard Chartered (LSE: STAN). Its shares fell by 77% from 2013-16 as it experienced major difficulties which included regulatory issues and declining profitability. However, under a new management team it has been able to deliver improved financial performance, with Standard Chartered expected to record a rise in earnings of 48% next year. With it trading on a price-to-earnings growth (PEG) ratio of 0.3, it seems to be worth buying.
WYG could also post a recovery in the long run. In the short run though, more share price falls could be ahead as investors may react with further negativity towards its update. For now, then, it may be a stock to watch rather than buy.
