Those of a nervous disposition might give up on this stock – but not us

·4-min read
Car Engine Ricardo
Car Engine Ricardo

Engineer and environmental consultant Ricardo has yet to set the world alight since our initial analysis in March last year, and fears of a global recession could weigh on sentiment for some time to come, especially as the company has exposure to the car industry.

Those who are of a nervous disposition, or need short-term cash, could be forgiven for giving up on the stock. But patient portfolio builders may feel able to hold on, especially as the balance sheet looks capable of seeing the West Sussex concern through any downturn and a reshaping of the business mix is still capable of bringing long-term benefits.

Last week’s results for the financial year to the end of June reported a pleasing increase in orders, sales, profits and the dividend.

Better still, net debt is down and, as regular readers will know, this column takes the view that less debt means less risk and less risk can mean a higher share price, or at least merit a higher multiple of earnings (the price investors are willing to pay for profits in the form of the price-to-earnings or p/e ratio, which helps to determine a share price and a stock’s valuation).

The sale of the Ricardo Software operation after the end of the financial year for a maximum of £16.8m, with the receipt of £14.3m on completion of the deal, should further buttress the balance sheet. However, even before that, deal investors could draw some comfort from the company’s lowly net debt of £35m, for a gearing ratio of just 18pc when set against shareholders’ funds (or net assets) of £198m.

A study of two much-followed financial metrics, the curiously named “quick” and “current” ratios, also suggests that Ricardo has the mettle to confront a recession. The “current” ratio – the aggregate of trade receivables, inventory, assets for sale and cash divided by the aggregate of trade payables, short-term debt and leases and other current liabilities – is 2.

The quick ratio – which excludes inventory and assets for sale, to be even more rigorous – comes to around 1.7. Any score above 1 suggests that a business has enough cash and ready liquidity to meet its obligations on a one-year view and is a fair indicator that it could withstand an unexpected crisis.

Our other potential source of protection is valuation. The 430p share price compares with past peak earnings per share, adjusting for last year’s fundraising, of around 47p. A multiple of less than 10 times that, for a business that is moving to position itself as an engineer and consultant in a number of specialist, technical industries such as energy, rail, defence and high-performance cars, does not feel like a stretch.

What we are missing, though, is a catalyst to make investors revise their opinion of the stock and this is where patience will be required.

The strategy of Graham Ritchie, the chief executive, and his team will need time to prove itself, via improved earnings and cash flow. The economic environment may not help here but, again, the balance sheet should.

We’ll keep hold of Ricardo.

Questor says: hold

Ticker: RCDO

Share price at close: 430p

Update: Serco

A capital gain of some 11pc, supplemented by 2.55p a share in dividends, may not feel like much of a return on holding Serco, the support services company, for more than five years. But that is the fault of this column for paying the wrong price (146.3p), one that had factored in much of the turnaround before it had begun.

At least we did not panic when the shares hit 82p in late 2018 and the decision by Rupert Soames, the chief executive, to retire feels like an opportune moment to reassess.

A broad spread of long-term, government-backed contracts provides relatively good visibility at a time of economic uncertainty. The business is simpler and more focused, while the balance sheet is much stronger and cash flow is good. An internal appointment as the new boss, Mark Irwin, offers welcome continuity.

But a p/e ratio in the mid-teens feels about right for a company with Serco’s mid-single digit profit margins and a trend rate of sales growth in the low to mid-single digits.

It’s time to book our small gain. Sell.

Questor says: sell

Ticker: SRP

Share price at close: 162p

Russ Mould is investment director at AJ Bell, the stockbroker

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