Last updated on December 17th, 2022 at 02:01 pm
We examine 3 turnaround stocks that have the potential to recover and you need to keep an eye on.
sentiment. Bargain hunters have begun scouring the market for undervalued gems, but are there any truly undervalued diamonds in the rough?
It’s uncommon for a stock to be undervalued for no apparent reason. Risk is usually priced into the market. However, there are a few companies worth investigating further because of their compelling turnaround potential.
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Here is 3 turnaround stocks to keep an eye on
Facebook’s about-face |
Following disappointing fourth-quarter results, Meta’s stock is trading near all-time lows. Revenue growth of 20% was more than offset by rising costs, resulting in a 1% drop in operating income. More concerning was management’s prediction that growth would slow significantly in the coming year. This is the result of increased competition and changing consumer habits. Because of the growing popularity of video content, Meta is having difficulty increasing the number of ads it can sell.
Things are difficult. However, we believe the market’s reaction was overly harsh.
Meta has an unrivaled database of customer information. The company owns the world’s largest social media network. It has access to a wealth of customer data that advertisers require in order to attract attention to their product. That should serve it well if inflation forces the industry to tighten its belts.
Meta is also sitting on a sizable sum of money. The organization should be able to put those funds to good use. There’s still a lot of work to be done. We’d like to see Meta expand its messaging capabilities and find a way to monetize them. It’s an appealing opportunity to have two of the top three messaging services under the Meta umbrella.
Meta appears to be focused on the metaverse in the long run. The company is adamant that its growing spending won’t go toward this goal in the short term, but improved IT infrastructure and AI capabilities won’t hurt either. It’s been difficult to get excited about this part of the business because it’s murky and loses money. The metaverse has the potential to be a future growth driver, but we’ll need a more defined strategy before we can consider it a positive.
Right now, the market is doubting Meta. Future-proofing a business is a costly endeavor, and advertising revenue will be required to cover the costs. This is becoming a problem, but it does not appear to be insurmountable.
Meta could get back on track if management can figure out how to better monetize video content and generate meaningful returns from messaging.
Royal Mail delivers change
The pandemic provided an opportunity for Royal Mail to expand its operations. The group needed to find a way to put parcels at the center of its operations due to the structural shift away from sending letters. We’ve been impressed with its progress so far that we’ve selected it as one of five stocks to consider for a Stocks and Shares ISA this year.
The volume of mail passing through the post office has increased significantly. This is good news for Royal Mail, and the company’s turnaround efforts should help it improve its bottom line.
Royal Mail used to sort the vast majority of its parcels by hand just a few years ago. That was an expensive and time-consuming method of doing things that ate into profit margins. By the end of this year, roughly half of all parcels sent through Royal Mail will have been automatically sorted. This lowers costs and gives the company more flexibility to deal with spikes in demand during peak seasons like the holidays.
However, putting the infrastructure in place to automate is costly. The company intends to spend more than £400 million in the UK alone next year.
The most important improvement – management’s relationship with unions – should also be discussed.
Wages are Royal Mail’s largest outgoing, so any significant efficiency gains will have to be accompanied by staff reductions and pay changes. So far, we’ve been impressed with management’s ability to enlist the help of the unions in its cost-cutting efforts. The next step will be to cut 700 management positions, which will save the company around £40 million per year. However, getting the unions to agree is a tall order.
GLS, an international company, is also part of the group. With operating margins of 8%, compared to Royal Mail’s 3.7 percent, this part of Royal Mail has been a growth engine.
This arm has been steadily growing thanks to small acquisitions, a strategy that has kept cash demands low. This side of Royal Mail has a lot of variety, which is a plus. However, it exposes the company to additional risks from economic slowdowns in other countries.
The market is skeptical of the company’s ability to achieve its efficiency goals. Shares are traded for six times expected profits, which is low by historical standards and well below the long-term average. At the time of writing, the prospective dividend yield is inflation-beating and well-covered by free cash flow. However, there is no guarantee of a dividend.
However, there are reasons to be cautious. There will be little room for progress if the group can’t get the unions on board with its efficiency goals.
Tate & Lyle’s sweet and sour recovery
The company’s namesake sugar brand, Tate & Lyle, is no longer a part of Tate & Lyle. Sweeteners, thickeners, and bulk commodities are now the focus of the group.
It recently underwent a major strategic overhaul, selling off the business’s least profitable parts and refocusing on higher-growth areas. This is expected to close in the spring, bringing with it a £900 million windfall, with £500 million set aside for shareholders.
However, the sale provides shareholders with more than a one-time benefit. Margin has been held back in parts of the Primary Products business that are being sold. Operating margins increase from 11.1 percent to 14.8 percent without them.
Underlying operating profits (6 months to 30 September 2021)
Changes of this magnitude, of course, come with a healthy dose of uncertainty. The remaining funds from the sale will be used to pay down debt. We applaud this decision, especially as interest rates rise and debt service costs increase.
Flexibility, on its own, does not, however, make or break a company. We’d prefer to see Tate & Lyle use its more agile frame for something.
The first order of business for management is to put a greater emphasis on healthy eating, which we support. As a more health-conscious public seeks ways to clean up its diet, the company is in a good position to expand its presence in sugar-alternatives.
Then there are the more immediate concerns. Ukraine is a major corn exporter, which Tate & Lyle relies on. Corn prices are now skyrocketing, threatening to eat into margins if the trend continues. In the short term, the group’s previously agreed contracts should keep the situation from becoming too chaotic. However, if prices remain high, a rude awakening may be on the way.
Tate & Lyle appears to be on the verge of a complete turnaround. The company could be on track for impressive growth if management can stay the course and use its new cash pile wisely.
The stock market is also getting excited, with shares trading well above their long-term average. This is a vote of confidence, but it could lead to more ups and downs in the short term if there are any unexpected speed bumps.
Read also: How to keep spices fresh and smell fresh for long periods
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