These growth stocks could be trading below fair value

Diamonds

Shares of FTSE 250 diamond miner Petra Diamonds Limited (LSE: PDL) fell 8% to a 52-week low of 102p on Wednesday, after the group warned that production delays would hit profits for the year ending 30 June.

Petra has been ramping up production after a number of expansion projects, but this process has taken longer than expected. The company now expects this year’s production to be 8%-9% below its previous guidance of 4.4m carats. Revenue is expected to be about $485m, below forecasts of $533m.

Frustratingly, the company has chosen not to provide a revised estimate of earnings, other than to note that these will be below market expectations. Based on what we do know, I’d expect earnings to fall at least 10% below consensus forecasts of $0.12 per share, possibly more.

Despite this, today’s news isn’t necessarily a disaster. The company emphasised that it has now reached an operating rate which supports 2017/18 production guidance of around 5m carats. Assuming conditions remain stable in the diamond market, cash flow and profits could rise steadily over the next year.

Indeed, if forecasts for the year ahead remain unchanged, Petra stock now trades on a 2017/18 forecast P/E of 6.8 with a prospective yield of 2.6%. This might be attractive, except for one big risk factor.

In today’s update, management advised that they have had “initial constructive discussions” with lenders about “the likely shortfall in the upcoming ratio measurement”. This seems to suggest that the company is in danger of breaching its lending covenants when they’re tested at the end of June.

If trading improves next year as expected, this probably won’t be a big issue. But if things don’t improve, shareholders could face dilution in a potential refinancing. For this reason, I won’t be investing.

A turning point?

Butcher and food-to-go chain Crawshaw Group (LSE: CRAW) fell 13% after releasing a trading update on Wednesday. The company said that during the five months since February, sales have risen by 5.1%. However, like-for-like (LFL) sales have fallen by 4.5% during the same period.

The rate at which LFL sales are falling has slowed from 7.3% last year. But today’s figures seem to suggest that Crawshaw is opening new stores while sales are still falling in older shops.

The company put in place turnaround initiatives aimed at improving LFL sales at the end of last year. We’ll get more of an idea of how successful these have been when the group publishes its interim results, which I’d expect in September.

These should also provide more details about Crawshaw’s joint venture with meat and food producer 2 Sisters Food Group, which was announced in April.

2 Sisters founder Ranjit Boparan has invested £5.1m at 15.2p per share for a 29.9% stake in the group. He also has warrants to acquire a further 20.1% of the group at the same price, if the share price reaches 40p.

This deal has resulted in some dilution for Crawshaw shareholders. But management expects the 2 Sisters deal to provide “a greater range and better availability to our customers”. This could be a foundation for improved profit margins and sales growth.

Overall, Crawshaw seems to offer a mix of potential risk and reward. My view is broadly neutral, so I won’t be investing.

This stock could climb 45%

If you invest in growth stocks, then I’m confident you’ll want to know more about this UK small-cap stock. Our top analysts believe the fair value of this home-grown company could be 45% more than its current market cap.

I can’t reveal the name of this stock here. But you can find full details of this potential buy in 1 Top Small-Cap Stock From The Motley Fool.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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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