Shares of serviced office group IWG (LSE: IWG) fell by more than 30% this morning after the group — previously known as Regus — issued a major profit warning.
A hoped-for improvement in sales during the third quarter hasn’t happened. As a result, the company says that full-year operating profit for 2017 is now expected to be “materially below market expectations and in a range of between £160m to £170m”.
Operating profit last year was £185m, so today’s news suggests this figure will fall by around 10% this year. That’s very disappointing, considering that the stock was priced for earnings per share growth of around 20% this year.
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Have the shares fallen too far?
The group’s revenue fell by 0.4% during the first six months of 2017, excluding exchange rate effects. According to today’s update, the equivalent figure for the first nine months of the year is 1.9%. This suggests to me that the third quarter may have been pretty grim.
The company says that “weakness in London” and “disruption” as a result of natural disasters in overseas markets has hit the performance. But it stresses that if closed centres are excluded, sales rose by 4.4% during the third quarter, excluding exchange rate effects.
Indeed, the board remains “very positive about the opportunity” for the serviced office business. The company will continue to spend money opening new centres, in order to lay the foundations for future growth.
Is this an opportunity for buyers with long-term vision? I’m not convinced. Businesses of this type run a particular risk. They must commit to long leases on the buildings they operate, but their customers only have to commit to very short tenancies. So a shift in market conditions can result in lots of expensive empty buildings.
Even after today’s fall, I estimate that the stock trades on a 2017 forecast P/E of 16, with a likely yield of just 2.6%. That doesn’t seem cheap enough to me, given the risk of a further profit warning.
A stock I’d buy today
The outsourcing sector has been a pretty dangerous place to invest over the last year. But at least one company seems to have avoided the problems that have hit many of its rivals.
Engineering services group Babcock International Group (LSE: BAB) has lost nearly 20% of its market value of the last year. But the firm’s latest trading update confirmed that results for the current year are expected to be in line with market expectations. That means that earnings per share are expected to rise by 35% this year.
One reason for the group’s more robust performance may be its engineering specialism. Whereas much of the work carried out by other outsourcing firms involves low-paid work, Babcock staff provide skilled engineering services to clients including the Royal Navy. The company is also involved in the nuclear power sector.
It says that 89% of revenue is now confirmed for the year ending 31 March 2018. That ought to provide management with fairly good visibility of profits for this year. The shares now trade on a forecast P/E of 10, with a prospective yield of 3.6%.
If Babcock can maintain its current level of performance, I believe the shares should offer good value at current levels.
