Are these FTSE 250 growth stocks getting too pricey?

RPC Group

Shares of plastics firm RPC Group (LSE: RPC) fell by about 3% this morning, despite the group’s adjusted pre-tax profit climbing by 78% to £286.1m last year. Sceptical shareholders were not mollified by news that they will receive a full-year dividend of 24p per share, an increase of 50% on last year.

One reason for these doubts is that RPC’s impressive performance has been fuelled by two major acquisitions. RPC spent about £800m buying UK firm British Polythene Industries and French bottle-top maker GCS in 2016. The group has already splashed out another £552m this year on US firm Letica Group.

Stock market history is littered with the graves of companies who acquired too much, too quickly. So today I’ll be asking if RPC’s balance sheet and valuation are still appealing after such a rapid transformation.

2 things to watch for

By issuing new shares to help fund last year’s acquisitions, RPC has managed to keep debt levels under control. Net debt rose from £744m to £1049m last year, which represents a multiple of 1.8 times the group’s pro forma EBITDA. This includes notional full-year contributions from the companies acquired during the course of the year.

I’m comfortable with this level of borrowing and am also pleased to see that the firm’s adjusted earnings per share rose by 54% to 62.2p last year, despite the impact of the rights issue.

The shares now trade on 13 times adjusted earnings or 22 times reported earnings, which include acquisition-related costs. In my view this is probably high enough for now, but I don’t see any reason to sell, and wouldn’t rule out further gains. I’d hold.

Will this acquisition leave a bad taste?

Investing in takeaway sandwiches and ready meals has paid dividends for shareholders of Greencore Group (LSE: GNC), whose shares have risen by 300% over the last five years.

Like RPC, Greencore has been on the acquisition trail over the last year. The group spent $747.5m to acquire US firm Peacock Foods in 2016, giving it “a platform of real scale” for US growth, according to Patrick Conveney, Greencore’s chief executive.

The problem is that this growth has come at a price. Like RPC, Greencore issued new shares to help pay for this major deal. However, the increased share count led to a 6% fall in adjusted earnings per share during the first half.

Net debt also rose sharply during the first half, rising by £224.8m to £556.6m. This gives Greencore a net debt to EBITDA ratio of 2.7 times. That’s significantly higher than RPC, and above my preferred maximum of two times EBITDA.

In fairness, it’s still early days. The second half of the year is usually seasonally stronger and will include a much greater contribution from Peacock. This could help to reduce net debt and boost earnings, thus reducing leverage.

Consensus forecasts are for full-year adjusted earnings of 15.4p per share. This leaves the stock trading on a forecast P/E of 16, with a prospective yield of 2.1%. I’d hold for now, until we see how Greencore trades over the summer.

This could be the best FTSE 250 buy

Greencore and RPC may both deliver further gains. But here at the Motley Fool, our analysts have identified another FTSE 250 company which they believe could deliver far bigger profits.

The company concerned is a UK business with a well-known brand. We believe that the value of this business could rise by up to 200%.

If you’d like full details of this potential buy, download A Top Growth Share From The Motley Fool today. This exclusive report is free and without obligation. To get your copy, just click here now.

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Roland Head has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Greencore. The Motley Fool UK has recommended RPC Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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