3 FTSE 100 companies with recovery potential

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3 FTSE 100 companies with recovery potential
Master Investor Magazine

Master Investor Magazine Issue 59

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Robert Stephens, CFA, discusses the potential for three FTSE 100 companies to deliver share price turnarounds.

The FTSE 100 may have risen by over 5% in the past year, but some of its members have recorded large share price falls. In some cases, they are due to company-specific factors, while in others they have experienced difficult trading conditions.

Among those FTSE 100 companies which have declined in value over the past 12 months are Rolls-Royce (LON:RR), Sainsbury’s (LON:SBRY) and Shell (LON:RDSB). In my opinion, they could offer recovery potential over the long run.

Rolls-Royce

Rolls-Royce’s shares have fallen by 27% over the past year, as problems regarding its Trent 1000 engine have acted as a major headwind in its civil aerospace segment. They are likely to continue in the near term, and the company expects them to contribute to its financial performance for the full year being at the lower end of its previous guidance.

However, recent trading updates suggest that the business is gradually overcoming the issues it faces ahead of the release of its full-year results this week.

Furthermore, its cost savings and restructuring plans could offset the additional costs associated with its Trent 1000 engine so that it meets its target of £1bn free cash flow in 2020.

In the long run, Rolls-Royce could benefit from rising demand within the defence sector. Global military spending is forecast to continue its recent increase to rise by 3.3% per year through to 2023. Given improving trading conditions, the stock’s forward price-earnings ratio of 15.6 suggests that it offers recovery potential.

Sainsbury’s

Sainsbury’s has faced a mix of challenging operating conditions, as well as uncertainty regarding its failed strategy to purchase Asda. This has contributed to a 28% decline in its share price in the last year, as well as a change in its senior management.

It now plans to close unprofitable stores, reduce costs and ease the debt burden on its balance sheet. All of these measures could improve its financial performance, and may strengthen the business in a period where competition from discount retailers such as Home Bargains and B&M is increasing.

A potential catalyst for Sainsbury’s shares could be a rise in consumer confidence. It has increased by five points since the general election to now stand at minus nine. It could improve further due to wage growth being ahead of inflation, and consumers having more money to spend in real terms each month. The stock’s price-earnings ratio of 10.6 implies that it offers a margin of safety at the moment.

Shell

Shell’s fourth quarter results highlighted the reasons behind its 20% share price fall in the past year. Lower oil and gas prices contributed to a 36% year-on-year fall in its profit. It also experienced weaker realised refining and chemicals margins compared to the prior year.

Those same challenges could persist in the short run. The spread of coronavirus is threatening demand for gas in China and other countries, while in Europe an oversupply of gas is causing its price to weaken.

This situation could provide a buying opportunity, since Shell’s shares now have a price-earnings ratio of 13.2. As ever, it remains dependent on oil and gas prices recovering. That outcome may seem distant at the moment, but in the meantime the stock’s 7.3% yield could increase its investment potential.

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