Is it safe to buy cyclical stocks at the moment? And should we be avoiding retailers with bricks-and-mortar stores?
These aren’t easy questions. In addition to Brexit, there’s wider uncertainty about just how healthy the UK economy really is.
My view is that when picking stocks, it’s better not to generalise too much. Instead, I try to focus on company fundamentals and look for good businesses with the potential to continue improving.
In this article I’ll look at a promising small cap and revisit battered utility stock Centrica (LSE: CNA).
So many risks
The Topps Tiles (LSE: TPT) share price has fallen by more than 50% over the last four years, as investors have priced in the risk of a housing market slowdown and a possible recession.
After all, this business depends on people who are buying new homes or refurbishing existing ones. A recession could see sales fall sharply.
The shares are down by a further 6% today after the company issued a year-end trading update. Sales were broadly flat during the year ended 28 September, but like-for-like sales fell by 1.9% during the final quarter.
Profits for the year are expected to be in line with forecasts for adjusted pre-tax profit of £15.5m to £16m. This compared with a figure of £16m last year, so it seems that Topps Tiles have just about kept things stable over the last year.
Is the price right?
Store-based retail is a tough business and I certainly by a lot of stuff online now. But my experience of buying tiles is that it is still useful to visit stores when choosing what to buy.
Topps isn’t without risk but it appears to be a successful player in this sector with a strong financial track record. This business is more profitable than most other UK retailers and benefits from a strong brand. A recent move into the commercial tile market is said to have doubled the group’s addressable market, which could help strengthen the business during lean times.
TPT shares now trade on about 10 times forecast earnings, with a 5% dividend yield. Although the outlook is uncertain, this business still looks healthy to me, financially. I’d consider Topps Tiles as a contrarian buy.
Centrica: patience required
British Gas owner Centrica doesn’t enjoy the high returns on capital earned by Topps Tiles. Instead, Centrica’s capital-intensive business model relies on spending huge amounts to generate a small annual return over many years.
It’s not necessarily a bad business model, in my opinion. Problems arise when the assumptions behind long-term spending decisions are upset by changing market conditions or political and regulatory interference.
That can leave firms facing losses or unable to make sensible investment decisions. In my view, this is the main reason why Centrica (and other UK utilities) have performed so poorly for their shareholders in recent years.
As things stand, I believe Centrica stock is probably decent value at the moment. Indeed, I recently added to my personal shareholding. For me, this is a long-term income holding. I’m prepared to wait. But I think that realising the value in this business – which remains the UK’s largest energy supplier – could be a slow process. I see this as a buy for patient investors only.
