So far, FTSE Small Cap share Stagecoach (LSE: SGC) has been a decent play for investors targeting so-called re-opening stocks. And the firm’s large bus operations and smaller rail business make the company an intuitive choice.
For me, the general theory is demand for bus and rail services will likely recover as the pandemic fades. And on top of that, the UK government has a clear agenda to promote the use of public transport services in the months and years ahead.
Stagecoach stock shot higher
And when Stagecoach shares were on their knees back in October 2020, they proved to be a good purchase. Shareholders buying around 37p last autumn saw the stock soar as high as around 108p by April 2020. However, it’s since drifted back and stands at almost 89p, as I write. Perhaps we’re seeing a second chance to bite the cherry.
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But to put things in context, the share price was as high as 75p a year ago. I think the volatility reflects investor sentiment and the ups and downs of news flow regarding the epidemic in this country.
However, it’s also worth bearing in mind that Stagecoach operates a low-margin business and carries a lot of debt. There’s a history of volatility in the record of earnings. And prior to the arrival of Covid 19, the stock had been trending lower since the summer of 2015 as it shed rail operations and other factors.
It’s fair to say that Stagecoach shares come with plenty of risks. And we’re not talking about a quality enterprise here in terms of all the usual financial indicators. For example, the firm has a low operating margin and is producing wafer-thin returns against invested capital.
In an update delivered on 26 March, the company owned up to being unable to predict when profit margins will recover in the short term. But the directors are bullish about the long-term prospects for the business. And one positive they pointed to is the UK government’s recently announced National Bus Strategy for England. The directors reckon it shows a commitment to increasing bus patronage with “significant funding” to support the sector.
Hunting for quality
However, I’d rather invest in a business with chunky profit margins, high returns against equity and capital, and decent opportunities to expand and grow earnings. If I put my negative hat on for a moment, a business relying on government funding to succeed strikes me as being in a precarious position.
Nevertheless, after a long period of decline, there’s a good chance the Stagecoach business will continue its turnaround in the months and years ahead. However, progress for the business and for the stock could be slow from where things are today.
My guess is the fast reopening returns have already been made from this share. And if I invested in the stock now, it would be a buy-and-forget purchase aimed at holding for the long haul.
Today’s 89p share price puts the forward-looking earnings multiple near 21 for the trading year to May 2022. I’m in no hurry to buy, and if I do it’ll be because the stock has drifted even lower and the value has become compelling. However, nothing is guaranteed. And I could be wrong in my assessment of the prospects for the business and the stock!
